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Answer: The stress test does not account for the likely responses of other financial institutions to changes in the core variables of the test.
C is correct. In addition to a scenario's immediate impacts, analysts should consider its knock-on effects, or the impacts of how firms (particularly other financial institutions) respond to the scenario. A stress test should not only account for the direct effects of a given scenario but also the indirect effects that arise from the reactions and responses of other financial institutions to the core variables of the test. This comprehensive approach ensures a more robust and realistic assessment of the potential risks and their implications on the financial system.
Author: LeetQuiz Editorial Team
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A
Relationships between core and peripheral variables in the model are found by regressing their past behavior during stressed market conditions only.
B
Credit risk losses are modeled by mapping historical default rate data provided by credit rating agencies to estimates of gross domestic product.
C
The stress test does not account for the likely responses of other financial institutions to changes in the core variables of the test.
D
A scenario used in the stress test was developed using reverse stress testing.
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