FRM Part I · FRM Exam Part I · Stress Testing
Which feature best describes reverse stress testing as used by risk managers?
Reverse stress testing begins with a predefined unacceptable outcome, such as a large loss or failure of the business model, and works backward to identify the scenarios that could produce it. This reveals vulnerabilities that conventional forward scenarios may overlook.
- AApplying a historical crisis shock to the current portfolio
- BShocking one risk factor at a time to measure sensitivity
- CIdentifying scenarios that would cause a predefined unacceptable loss or failure of the business modelCorrect
- DBack-testing VaR forecasts against realized profit and loss
Explanation
Reverse stress testing starts with a defined adverse outcome, such as breaching capital limits or insolvency, and works backward to find the combinations of events that would cause it. This helps uncover hidden vulnerabilities that forward-looking scenarios might miss.
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