FRM Part I · FRM Exam Part I · Stress Testing
A risk committee notes that its stress scenarios are all derived from the worst historical outcomes of the past 15 years. Which is the most significant limitation of relying solely on this approach?
The main limitation is that historical scenarios may miss new risks, changes in current portfolio exposures and events never seen before, leaving blind spots. They can be translated into risk factor shocks and reviewed by management, and are not inherently more severe than hypothetical scenarios.
- AHistorical scenarios cannot be expressed in terms of risk factor shocks
- BHistorical scenarios are always more severe than any hypothetical scenario
- CHistorical scenarios cannot be reviewed by senior management
- DHistorical scenarios may fail to capture new risks, changed portfolio exposures or events with no precedent, creating blind spotsCorrect
Explanation
Historical scenarios are anchored in past events and may miss emerging vulnerabilities, structural changes or unprecedented combinations of shocks. They can be expressed as factor shocks and reviewed by management, and they are not necessarily more severe than hypothetical ones.
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