Skip to content

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

Two scenarios are applied to a portfolio. Scenario A shocks equities by -30% and implies a portfolio loss of 15% with a Mahalanobis distance (a measure of how unusual the joint move is relative to history) of 3.0. Scenario B shocks credit spreads and implies a loss of 12% with a Mahalanobis distance of 1.5. The risk manager must pick one scenario for a limit framework that targets severe but plausible events. Which conclusion is best supported?

Scenario A has a bigger loss but a much larger Mahalanobis distance, meaning it is a rarer, less plausible joint move. Scenario B is more plausible but less severe. Which to use depends on the plausibility level the limit framework targets, not on loss size alone.

  1. AScenario A is preferred because it has the larger loss regardless of plausibility
  2. BScenario B is more plausible but less severe, so the choice depends on the target plausibility level; A is the more extreme and less likely eventCorrect
  3. CBoth are equally plausible because their losses are within 3 percentage points
  4. DScenario B must be discarded because its distance is below 2

Explanation

A larger Mahalanobis distance means a more unusual, less likely joint move. A has the larger loss but is less plausible; B is more plausible but less severe. Selecting depends on the plausibility level the framework targets, and loss size alone does not settle it.

Did you get it right without looking?

One question tells you little. A timed set on Market-Driven Scenarios: An Approach for Plausible Scenario Construction shows your real accuracy, how long you take and where you lose marks.

Practise Market-Driven Scenarios: An Approach for Plausible Scenario ConstructionFree diagnostic mock

More Market-Driven Scenarios: An Approach for Plausible Scenario Construction questions