FRM Part II · FRM Exam Part II · Market-Driven Scenarios: An Approach for Plausible Scenario Construction
A risk team builds a market-driven scenario by choosing one market factor as the 'anchor' shock and then deriving shocks to all other factors from the anchor. Which description best captures how the other factors' shocks are determined?
The other factors' shocks are set to their conditional expected values given the anchor shock, using the estimated joint distribution and correlations. This makes the scenario internally consistent and plausible, unlike assigning equal percentile moves, zero shocks, or independent worst-case moves.
- AEach is set to the same percentile move as the anchor factor, regardless of correlation
- BEach is set equal to its conditional expected value given the anchor shock, using the estimated joint distribution and correlationsCorrect
- CEach is set to zero so that only the anchor factor contributes to the scenario loss
- DEach is set to its historical worst one-day move independent of the anchor
Explanation
Market-driven scenario construction conditions on a shock to a chosen factor and uses the joint distribution (correlations) to compute the expected shocks of the remaining factors. This keeps the scenario plausible. Setting all factors to the same percentile ignores correlation structure, and zeroing or independent worst moves are not conditional expectations.
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