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

Which feature distinguishes reverse stress testing of counterparty exposures from standard scenario-based stress testing?

Reverse stress testing begins with a specified unacceptable outcome, such as a loss that threatens viability, and works backward to identify the scenarios that could cause it. Standard stress testing instead starts with a chosen scenario and measures the resulting loss.

  1. AIt starts from a defined unacceptable loss and searches for the scenarios that would cause itCorrect
  2. BIt applies only the shocks prescribed by the regulator
  3. CIt estimates losses only under average market conditions
  4. DIt removes the need for senior management review of results

Explanation

Reverse stress testing works backward from a predefined failure or loss threshold to identify the combinations of events that could produce it, which can reveal vulnerabilities that forward scenarios miss. The other options describe unrelated or incorrect features.

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