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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 rather than a purely narrative, event-based approach. Which description best captures the starting point of the market-driven approach?

The market-driven approach begins by shocking one or a few key market variables and then derives the moves in the other risk factors from their statistical relationships in market data, so that the whole scenario is coherent and plausible, unlike a pure narrative or independent shocks.

  1. AChoose a historical crisis date and apply its observed factor moves unchanged to the current portfolio
  2. BAsk a committee to imagine a severe macroeconomic event and assign subjective shocks to each risk factor
  3. CSpecify a shock to one or a few key market variables and let the shocks to remaining variables follow from the statistical relationships in market dataCorrect
  4. DSet all risk factor shocks equal to their historical 99th percentile moves independently

Explanation

The market-driven approach starts from a shock to a chosen set of market variables and infers the conditional behaviour of the other variables from their joint statistical relationship in market data. This keeps the scenario internally coherent. Replaying a past crisis or setting independent percentile shocks ignores this conditional logic.

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