Skip to content

FRM Part I · FRM Exam Part I · Stress Testing

A risk manager notes that a stress test using historical scenarios, such as the 2008 crisis, may fail to capture future vulnerabilities. Which approach best addresses this limitation?

Adding hypothetical scenarios and reverse stress tests best addresses the limitation of historical scenarios. These approaches look for plausible but unprecedented events, including those that would cause the firm to fail, rather than relying only on what has already happened.

  1. AUse only the most recent year of market data to calibrate scenarios
  2. BAdd hypothetical scenarios and reverse stress tests that identify events that would break the business modelCorrect
  3. CReduce the severity of historical scenarios to improve plausibility
  4. DReplace stress testing with a higher VaR confidence level

Explanation

Hypothetical forward-looking scenarios and reverse stress testing explore vulnerabilities not seen in history. Recent-only data tends to be benign, reducing severity weakens the test, and VaR at higher confidence still relies on historical distributions rather than extreme tail events.

Did you get it right without looking?

One question tells you little. A timed set on Stress Testing shows your real accuracy, how long you take and where you lose marks.

Practise Stress TestingFree diagnostic mock

More Stress Testing questions