FRM Part I · FRM Exam Part I · Stress Testing
A risk committee asks the risk manager to run a reverse stress test. Which of the following best describes what the risk manager should do?
The risk manager should identify scenarios that would produce a predefined unacceptable outcome, such as breaching minimum capital. Reverse stress testing starts from the failure result and works back to the events that cause it, unlike historical or hypothetical scenarios that start from the shock.
- AApply the 1987 equity crash to the current portfolio and report the loss
- BIdentify scenarios that would cause a predefined unacceptable outcome, such as breaching minimum capitalCorrect
- CIncrease the VaR confidence level from 95% to 99.9% and recompute
- DReverse the sign of all risk factor shocks used in the prior stress test
Explanation
Reverse stress testing fixes a severe outcome, such as capital falling below the regulatory minimum or insolvency, and searches for the combinations of events that would produce it. Applying a past crash is a historical scenario, and changing VaR confidence or flipping shock signs is not reverse testing.
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