FRM Part I · FRM Exam Part I · Stress Testing
Which of the following is the main limitation of stress testing relative to VaR as a risk measure?
The main limitation is that stress test results carry no associated probability, so deciding which scenarios are plausible and how severe they should be relies on management judgment. VaR gives a probability-based loss figure, while stress tests give loss magnitudes for chosen scenarios.
- AStress tests cannot incorporate liquidity or second-round effects of any kind
- BStress test results come without an associated probability, so judgment is needed to decide how likely and how severe a scenario should beCorrect
- CStress tests can only be applied to equity portfolios
- DStress tests require the assumption of normally distributed returns
Explanation
Stress tests do not generally assign probabilities to scenarios, so selecting severity and plausibility relies on judgment. They can incorporate liquidity and feedback effects, apply to any portfolio, and do not require normality.
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