FRM Part I · FRM Exam Part I · Stress Testing
Which statement about using stress testing alongside VaR is most accurate?
Stress tests complement VaR by examining extreme but plausible events that may lie outside the historical data used for VaR. However, they typically do not attach a probability to the scenario and rely on judgment in choosing it.
- AStress tests give the probability of the stressed loss, which VaR cannot
- BStress tests can capture extreme events outside the historical data used for VaR, but they typically do not assign a probabilityCorrect
- CStress tests replace VaR because they cover all possible outcomes
- DStress tests are only valid if the scenario follows a normal distribution
Explanation
Stress tests explore plausible severe events that may not appear in the VaR data window, complementing VaR. Their weakness is that scenarios generally lack an assigned probability and depend on judgment. They do not cover all outcomes and require no normality assumption.
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