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FRM Part II · FRM Exam Part II · Liquidity Stress Testing

A risk manager is calibrating the severity of a market-wide liquidity scenario. Which approach best reflects the concept of a severe but plausible scenario that avoids reliance solely on past history?

The best approach builds a hypothetical narrative scenario informed by history but extended to reflect the bank's current vulnerabilities, like concentrated funding. Pure historical replay misses emerging risks, regulatory run-off rates are only a baseline, and selecting mild shocks to fit risk appetite undermines the test's purpose.

  1. AReplay the worst single day of outflows from the past five years and add no further shocks
  2. BUse a hypothetical scenario built from a narrative of market-driven events, with shocks informed by history but extended to reflect current vulnerabilities such as concentrated fundingCorrect
  3. CSet shocks equal to the regulatory minimum run-off rates for all products
  4. DChoose the scenario with the smallest cash impact so results remain within risk appetite

Explanation

Severe but plausible scenarios combine history with forward-looking judgment about current vulnerabilities. Pure replay misses new risks, regulatory rates are a floor rather than a firm-specific design, and choosing mild shocks defeats the purpose of stress testing.

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