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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 to build a stress scenario using the market-driven approach to plausible scenario construction. Which feature best distinguishes this approach from a traditional historical or hypothetical scenario?

The market-driven approach uses market prices and observed relationships to propagate a shock in selected factors to all other risk factors. This produces internally consistent, plausible scenarios, unlike arbitrary independent shocks, simultaneous worst-case moves, or simple replays of a historical crisis.

  1. AIt relies on market prices to determine how shocks to one set of risk factors should propagate to other factors, giving internally consistent scenariosCorrect
  2. BIt uses only the worst single-day return observed for each risk factor and applies them simultaneously
  3. CIt requires management to assign arbitrary shocks to each factor independently of one another
  4. DIt replicates a past crisis exactly by applying the same factor moves to the current portfolio

Explanation

The market-driven approach starts from a chosen shock to a few key factors and uses market-implied relationships (for example, conditional expectations from observed prices) to infer the moves in other factors, so the scenario is coherent and plausible. Applying worst moves simultaneously or independent arbitrary shocks ignores plausible dependence, and exact replication is just a historical scenario.

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