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FRM Part I · FRM Exam Part I · Stress Testing

A bank's risk team wants to evaluate how its trading book would perform if a repeat of a specific past market episode, such as the 1998 Russian default and LTCM crisis, occurred. Which stress testing approach does this describe?

This is historical scenario analysis, because it applies the actual market movements recorded during a past crisis to the bank's current positions. Hypothetical scenarios are invented events, reverse stress tests begin from a target loss, and sensitivity analysis shocks only one risk factor.

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

Explanation

Historical scenarios apply the actual market moves observed during a past event to current positions. Hypothetical scenarios are constructed from plausible but unobserved events. Reverse stress testing starts from a loss level and seeks the scenarios producing it, and sensitivity analysis shocks one factor at a time.

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