Skip to content

FRM Part I · FRM Exam Part I · Stress Testing

In reverse stress testing, a risk manager begins by specifying that the bank's CET1 ratio must fall below its regulatory minimum. What is the next step in the process?

The next step is to identify the combinations of risk factor movements and events that could produce the capital breach and then assess how plausible they are. Reverse stress testing works backward from a defined failure outcome rather than forward from a given scenario.

  1. ACompute the 99% 10-day VaR of the trading book and compare it with capital
  2. BIdentify the combinations of risk factor movements and events that could cause that outcome and assess their plausibilityCorrect
  3. CApply the prior year's regulatory scenario to the current portfolio
  4. DScale all risk factor volatilities by a constant multiplier until the VaR doubles

Explanation

Reverse stress testing starts from an unacceptable outcome, such as capital breach, and works backward to find scenarios that could produce it, then judges their plausibility. The other options start from a given scenario or a statistical model, which is the forward approach.

Did you get it right without looking?

One question tells you little. A timed set on Stress Testing shows your real accuracy, how long you take and where you lose marks.

Practise Stress TestingFree diagnostic mock

More Stress Testing questions