FRM Part I · FRM Exam Part I · Stress Testing
A risk manager wants to identify which combinations of market moves would cause the bank to lose 15% of its Tier 1 capital, rather than assess the loss from a pre-specified scenario. Which technique is she using?
She is using reverse stress testing. It begins with a defined severe outcome, such as losing 15% of Tier 1 capital, and works backward to find the scenarios or factor combinations that could cause it, instead of starting with a scenario and computing the loss.
- ASensitivity analysis on a single risk factor
- BReverse stress testingCorrect
- CBack-testing of the VaR model
- DHistorical simulation
Explanation
Reverse stress testing fixes an adverse outcome, here a 15% capital loss, and searches for scenarios that produce it. Sensitivity analysis shocks one factor and measures the loss. Back-testing compares VaR forecasts with realized losses, and historical simulation estimates VaR from past data.
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