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

In constructing a plausible market-driven scenario, why does a risk manager set the non-shocked factors to their conditional expected values rather than leaving them unchanged?

Leaving other factors unchanged implicitly assumes they are uncorrelated with the shocked factor, which is unrealistic. Setting them at conditional expected values reflects observed co-movement, making the scenario more plausible and internally consistent.

  1. ALeaving them unchanged implies zero correlation with the shocked factor, making the scenario less plausibleCorrect
  2. BConditional values guarantee the scenario is the worst possible loss
  3. CUnchanged factors cannot be priced in a full revaluation
  4. DRegulators prohibit scenarios where only one factor moves

Explanation

Holding other factors at zero ignores the dependence observed in data and so is implicitly assuming independence. Conditional expectation reflects likely co-movements and improves plausibility. It does not ensure the worst case, and pricing and the regulatory claim are incorrect.

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