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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 builds a stress scenario by selecting a small set of key market variables, shocking them, and then using the historical covariance structure of all other risk factors to infer their conditional shocks. Which feature of this approach most directly supports the plausibility of the scenario?

Plausibility comes from implying the other factors' shocks from their estimated relationships with the shocked variables. Because the remaining moves follow the historical co-movement structure, the whole scenario is internally coherent, unlike independent worst-case shocks or zeroing out the other factors.

  1. AShocks to the remaining factors are set to zero to avoid double counting
  2. BEach factor is shocked independently by its worst historical move
  3. CShocks to the remaining factors are implied by their estimated relationships with the shocked variables, so the whole scenario is internally coherentCorrect
  4. DThe scenario probability is fixed at the 99% level by construction

Explanation

Market-driven scenarios shock a few chosen variables and propagate the effect to other factors through estimated co-movement (conditional expectations). This keeps the full scenario consistent with observed market relationships. Shocking each factor independently by its worst move ignores correlations and gives implausible combinations.

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