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FRM Part II · FRM Exam Part II · Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

A risk manager at a global asset manager reads that heightened geopolitical risk is associated with weaker growth and tighter financial conditions. Which portfolio-level response best reflects the report's emphasis on geopolitical risk as a source of financial stability vulnerability?

Scenario-based stress testing that traces geopolitical shocks through asset prices, funding and liquidity is the best response, because such events are rare and unlike recent history, so backward-looking VaR alone understates the tail risk and higher leverage would worsen vulnerability.

  1. ARun scenario-based stress tests that link geopolitical shocks to asset price, funding and liquidity channelsCorrect
  2. BRely only on historical VaR calibrated to the last 250 trading days
  3. CRemove all stress testing because geopolitical events cannot be forecast
  4. DIncrease leverage to benefit from higher expected risk premia

Explanation

Geopolitical shocks are rare and often unlike past data, so forward-looking scenario analysis that traces transmission through prices, funding and liquidity is appropriate. Short-window historical VaR understates tail risk from such events. Leverage raises vulnerability rather than reducing it.

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