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FRM Part II · FRM Exam Part II · Market-Driven Scenarios: An Approach for Plausible Scenario Construction

A scenario designer stresses equity by -20% when equity volatility is 4% per month. In a calm sample, the correlation between equity and a high-yield spread factor is -0.3; in a crisis sample it is -0.8. The spread factor has monthly volatility of 40 bps. Zero means are assumed. By how much does using the crisis correlation rather than the calm correlation raise the conditional expected spread widening?

Switching from the calm to the crisis correlation raises the expected widening by 100 bps. Calm gives 60 bps (beta 3 per 1% times 20) and crisis gives 160 bps (beta 8 times 20), so the difference is 100 bps, showing sensitivity to correlation regime.

  1. A100 bpsCorrect
  2. B60 bps
  3. C40 bps
  4. D160 bps

Explanation

Beta = rho x 40/4 = 10 rho bps per 1%. Calm: -3 x (-20) = 60 bps. Crisis: -8 x (-20) = 160 bps. The increase is 100 bps. 60 and 160 are the individual levels, not the difference.

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