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

A risk manager at an asset manager argues that purely historical stress scenarios, such as replaying 2008, are insufficient for stress testing the current portfolio. Which limitation of historical scenarios does the market-driven scenario approach primarily seek to address?

Historical scenarios may not reflect the current portfolio and market conditions and miss plausible events that have not yet happened. Market-driven scenario construction uses current market information to build forward-looking, plausible shocks, addressing this weakness.

  1. AHistorical scenarios cannot be expressed as shocks to risk factors
  2. BHistorical scenarios may not reflect current portfolio exposures and market conditions, and ignore plausible events that have not yet occurredCorrect
  3. CHistorical scenarios always overstate the correlations among risk factors
  4. DHistorical scenarios require more data than statistical VaR models

Explanation

Historical scenarios replay past events and may not match today's exposures or market structure, and they cannot capture plausible events that have not occurred. Market-driven scenarios use current market information to build forward-looking, plausible shocks. The other options are not the main motivation.

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