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FRM Part II · FRM Exam Part II · Market-Driven Scenarios: An Approach for Plausible Scenario Construction

A risk committee reviews a scenario result showing a 12% portfolio loss. The scenario was generated by shocking only the equity index by -25%, and the other factors were set to zero change. Which interpretation is most appropriate?

Holding other factors unchanged while shocking equities ignores their typical co-movement, so the scenario is internally inconsistent and the 12% loss may be misleading, either understated or overstated. A market-driven scenario would infer conditional moves in the other factors to produce a more plausible loss estimate.

  1. AThe loss is conservative because zero changes in other factors always produce the worst outcome
  2. BThe loss is likely unreliable as a plausible estimate because holding correlated factors unchanged ignores their expected co-movement with equitiesCorrect
  3. CThe loss equals the expected shortfall at the 97.5% level
  4. DThe loss is robust because a single-factor shock avoids model risk

Explanation

Setting other factors to zero ignores correlations, so the scenario may be implausible and can understate or overstate loss depending on exposures. A market-driven approach would project the other factors conditional on the equity shock. Nothing links the figure to expected shortfall.

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