FRM Part I · FRM Exam Part I · Stress Testing
Regulators ask a bank to identify the combination of events that would cause its capital ratio to fall below the regulatory minimum, starting from that failure outcome. Which feature best describes this exercise and its main benefit?
This is reverse stress testing. It starts from a defined failure outcome, such as capital falling below the minimum, and works backward to find the scenarios that would cause it, which can expose vulnerabilities that standard forward-looking scenarios may overlook.
- AReverse stress testing, which helps uncover vulnerabilities that conventional scenarios may not revealCorrect
- BSensitivity analysis, which shocks one factor at a time to estimate delta
- CHistorical simulation, which replays past returns to estimate VaR
- DBack-testing, which counts exceptions against VaR forecasts
Explanation
Reverse stress testing begins with a defined adverse outcome, such as breaching minimum capital, and searches for scenarios that produce it. This can reveal hidden concentrations and vulnerabilities that scenarios designed from the front end may miss. The other options do not start from a failure outcome.
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