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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 avoid the criticism that purely historical or purely hypothetical scenarios are arbitrary. Which feature best characterizes a market-driven scenario approach for this purpose?

A market-driven scenario approach uses current market prices and market-implied information, such as implied volatilities, to calibrate shocks and judge plausibility. This ties severity to observable data rather than to one past crisis or arbitrary management judgment, making the scenario more defensible.

  1. AIt uses current market prices and market-implied information, such as option-implied volatilities, to calibrate how likely the shocks areCorrect
  2. BIt replays a single past crisis exactly, with all risk factors shocked by their historical changes
  3. CIt asks senior management to nominate extreme shocks with no reference to market data
  4. DIt sets shocks by multiplying each risk factor's standard deviation by a fixed number such as five

Explanation

Market-driven scenarios anchor the scenario to current market information, such as implied volatilities and correlations, so shock severity and plausibility are tied to observable data. Pure historical replay and unconstrained judgment lack this link, and a fixed multiple of standard deviation ignores current market conditions.

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