FRM Part I · FRM Exam Part I · Stress Testing
A bank's stress-test team is choosing between historical and hypothetical scenarios. Which statement correctly identifies a limitation of relying only on historical scenarios?
Historical scenarios may miss risks arising from new products, changed market structure or relationships absent in past episodes, because they only replay what has already happened. They can still be applied to derivatives through revaluation, and their severity is not systematically below VaR.
- AThey cannot be applied to portfolios holding derivatives
- BThey require assumptions about the probability of each scenario to be stated
- CThey may miss risks from new products or structural changes not present in past episodesCorrect
- DThey always produce shocks that are less severe than VaR at 99%
Explanation
Historical scenarios replay past events, so they cannot capture vulnerabilities from new instruments, market structures or relationships that did not exist then. They can be applied to derivatives by revaluing positions. They do not necessarily need explicit probabilities, and severity can exceed VaR.
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