Financial Risk Manager Part 1

Explanation

Correct Answer: C - Imaginative future scenarios may be dismissed as inappropriate.

In scenario analysis, teams try to imagine different futures to help organizations prepare for a range of possibilities. However, in this process, certain proposed scenarios that seem too far-fetched, imaginative, or divergent from the norm may be dismissed as improbable or inappropriate. This is especially true for scenarios that may be considered as "black swan" events - events that are extremely rare but have severe consequences. Because these events are so rare and so difficult to predict, they may be ignored in the scenario planning process, often due to cognitive biases like the availability heuristic or normalcy bias.

Why Other Options Are Incorrect:

A is incorrect: In reality, determining the probability of events in scenario analysis can be quite challenging. Assigning probabilities to different scenarios often relies on subjective judgments, expert opinions, or assumptions, which can introduce biases and uncertainties. The difficulty in determining the probability of events accurately is a disadvantage, as it can lead to less reliable or less useful results.

B is incorrect: The number of appropriate situations that can be developed is not unlimited. Scenario analysis is constrained by practical considerations such as time, resources, and the ability to meaningfully analyze and interpret the scenarios. Developing too many scenarios can lead to analysis paralysis and dilute the focus on the most critical risks.

D is incorrect: Scenario analysis often does depend on historical data. While it involves forward-looking thinking, historical data provides important context, patterns, and benchmarks that help inform the development of realistic scenarios. Historical data serves as a foundation for understanding past trends and patterns that may influence future outcomes.