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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 wants stress scenarios that are plausible and tied to current market conditions, rather than purely historical episodes or arbitrary shocks. Which feature best characterizes the market-driven scenario approach?

The market-driven approach uses current market information, such as implied volatilities and correlations, to set how severe a shock is and how related risk factors move with it. This keeps scenarios plausible and forward-looking, unlike arbitrary shocks or simply combining the largest historical moves.

  1. AIt applies the largest historical one-day move of each risk factor simultaneously
  2. BIt uses information in current market prices, such as implied volatilities and correlations, to judge how plausible a shock is and to shape related factor movesCorrect
  3. CIt relies only on expert judgment, with no reference to market data
  4. DIt assumes risk factors are independent so that shocks can be set separately

Explanation

The market-driven approach calibrates scenario severity and the co-movement of other factors using forward-looking market information, such as implied volatility and correlations. This makes scenarios plausible and current. Applying maximum historical moves together ignores plausibility, and treating factors as independent ignores how they move together in stress.

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