Skip to content

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 internally consistent rather than arbitrary shocks to single factors. Which feature best characterizes the market-driven scenario approach to constructing such scenarios?

The market-driven approach shocks selected factors and uses observed market relationships and co-movements to infer how the other factors would move. This yields internally consistent, plausible scenarios, unlike single-factor shocks that hold everything else constant and ignore correlations.

  1. AUsing market prices and the observed co-movement of risk factors to determine how non-shocked factors respond to a chosen shockCorrect
  2. BSetting every risk factor shock equal to its worst historical one-day move
  3. CAssuming all non-shocked factors remain unchanged while one factor is shocked
  4. DSelecting shocks purely from the judgment of the senior portfolio manager without reference to data

Explanation

The market-driven approach picks a shock to a few key factors and uses market-based information, such as the estimated joint distribution, to infer the likely moves in other factors. This keeps the scenario coherent. Holding other factors fixed ignores correlations and can yield implausible scenarios.

Did you get it right without looking?

One question tells you little. A timed set on Market-Driven Scenarios: An Approach for Plausible Scenario Construction shows your real accuracy, how long you take and where you lose marks.

Practise Market-Driven Scenarios: An Approach for Plausible Scenario ConstructionFree diagnostic mock

More Market-Driven Scenarios: An Approach for Plausible Scenario Construction questions