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

A stress team is constructing a scenario for a portfolio exposed to factors A, B and C. They are deciding between anchoring on factor A or factor B, and they note that correlations rise sharply in crises compared with the calibration sample. Which implication is most consistent with the market-driven scenario approach?

Calm-period correlations will understate the co-movement implied in a crisis, because conditional expected shocks rise with correlation. The team should use crisis-reflective correlations and anchor on the factor where the portfolio is most sensitive, rather than assuming correlation or anchor choice is irrelevant.

1. AConditional expected shocks calibrated on calm-period correlations will understate co-movement; correlations should be estimated or stressed to reflect crisis conditions, and the anchor chosen where the portfolio is most sensitiveCorrect
2. BCorrelation changes do not affect conditional expected shocks because they depend only on the anchor shock size
3. CHigher crisis correlations reduce the conditional expected shocks, so calm-period estimates are conservative
4. DThe choice of anchor is irrelevant because all anchors always produce identical scenarios under any correlation estimate