FRM Part II · FRM Exam Part II · Market-Driven Scenarios: An Approach for Plausible Scenario Construction
A risk team builds a stress scenario by observing how a broad set of market variables have co-moved historically and then shocking a small number of core variables, letting the remaining variables move according to their estimated relationships with the shocked ones. Which feature of this market-driven approach most improves the plausibility of the resulting portfolio loss estimate?
Plausibility improves because non-core variables move in line with their estimated historical relationships to the shocked core variables, so the scenario is internally consistent, rather than relying on arbitrary independent judgmental shocks to each factor.
- AThe shocks to non-core variables are implied by historical co-movements rather than set independently by judgmentCorrect
- BEvery risk factor is shocked by the same number of standard deviations
- COnly risk factors with zero correlation to the core variables are shocked
- DThe portfolio is revalued using only the largest single-day historical loss
Explanation
Market-driven scenarios shock a few core factors and infer the moves in other factors from their historical relationships, which keeps the scenario internally consistent. Uniform shocks or ignoring correlated factors would produce implausible combinations of moves.
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