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FRM Part II · FRM Exam Part II · The Evolution of Stress Testing Counterparty Exposures

When choosing between a historical scenario and a hypothetical scenario for stressing counterparty exposures, which statement best reflects a sound design consideration?

Hypothetical scenarios can capture risks absent from past data, but they require careful judgement to keep them plausible and coherent. Historical scenarios are anchored in real events yet may miss new vulnerabilities, are not always more severe, and still need management review of their assumptions.

  1. AHypothetical scenarios can capture risks not seen in past data, but they need careful judgement to remain plausible and coherentCorrect
  2. BHistorical scenarios are always more severe than any hypothetical scenario
  3. CHypothetical scenarios are inappropriate because they cannot involve multiple risk factors
  4. DHistorical scenarios eliminate the need for senior management to review assumptions

Explanation

Hypothetical scenarios allow forward-looking events and new vulnerabilities, at the cost of needing judgement on plausibility and consistency. Historical scenarios are anchored in real events but may miss new risks, and are not necessarily more severe. Both can involve many factors and both need management review.

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