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FRM Part II · FRM Exam Part II · The Evolution of Stress Testing Counterparty Exposures

A bank's stress test of a margined counterparty uses a base margin period of risk of 10 days. Under stress, the bank assumes the period doubles to 20 days. Assuming the portfolio value follows a driftless random walk with constant volatility, by approximately what factor does the stressed potential exposure at a given confidence level increase relative to base?

Stressed potential exposure rises by about 1.41 times. With a driftless random walk, volatility over the margin period scales with the square root of time, so doubling the period from 10 to 20 days multiplies exposure by the square root of two.

  1. A1.41Correct
  2. B2.00
  3. C4.00
  4. D1.00

Explanation

Exposure over the margin period scales with the square root of time under a random walk. The factor is sqrt(20/10)=sqrt(2)=1.414. Choosing 2.00 treats risk as linear in time, which is the named mistake.

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