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FRM Part II · FRM Exam Part II · Stress Testing Banks

A bank's risk team is designing a stress test for its trading book. Rather than choosing a hypothetical shock, the team replicates the market moves observed during a past crisis, applying the historical changes in equity prices, credit spreads and interest rates to current positions. Which scenario design approach is this?

This is a historical scenario. It reuses the actual market changes seen in a past crisis and applies them to today's positions, unlike hypothetical scenarios, which are constructed from judgement, reverse stress tests, which start from a failure outcome, or single-factor sensitivities.

  1. AHistorical scenarioCorrect
  2. BHypothetical scenario
  3. CReverse stress test
  4. DSensitivity analysis on a single risk factor

Explanation

Applying actual market moves from a past episode to the current portfolio is a historical scenario. Hypothetical scenarios are constructed from forward-looking judgement about events that have not necessarily occurred. A reverse stress test starts from a defined failure outcome, and single-factor sensitivity shocks one variable only.

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