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FRM Part II · FRM Exam Part II · Portfolio Risk: Analytical Methods

Which statement best describes why scenario-based stress testing is used alongside analytical VaR?

Stress testing complements analytical VaR by examining extreme but plausible events beyond the VaR confidence level or outside the assumed distribution. VaR gives no information about tail losses past its quantile and depends on historical parameters, so scenarios reveal vulnerabilities VaR misses.

  1. AIt provides a more precise estimate of the 99% quantile under normality
  2. BIt eliminates the need to estimate volatilities and correlations
  3. CIt guarantees that losses will never exceed the stress loss
  4. DIt examines losses from extreme but plausible events that lie beyond the VaR confidence level or outside the assumed distributionCorrect

Explanation

VaR says nothing about losses beyond the confidence level and depends on assumed distributions and historical parameters. Stress tests explore extreme but plausible events and structural changes, complementing VaR. They do not give guarantees or a more precise quantile.

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