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Answer: Stress testing makes it possible to capture dependencies between asset classes in specific scenarios that cannot be captured well through a VaR-based system.
## Explanation **Correct Answer: B** Stress testing complements VaR by capturing dependencies between asset classes in specific scenarios that VaR systems may not adequately capture. VaR typically relies on historical data and statistical distributions, which may not fully account for extreme market conditions or complex interrelationships between different asset classes during stress events. **Why other options are incorrect:** - **A**: This is inaccurate because stress tests typically use fewer, more extreme scenarios, while VaR can incorporate many scenarios through historical simulation or Monte Carlo methods. - **C**: Stress testing is not necessarily more accurate than VaR in predicting probability of losses; they serve different purposes. VaR focuses on probability-based estimates, while stress testing examines extreme but plausible scenarios. - **D**: Stress testing is not restricted to macroeconomic variables only; it can incorporate various factors including market, credit, liquidity, and operational risks.
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A manager at an asset management firm relies on a VaR-based risk measurement system that calculates VaR for each of the firm's portfolios as well as an aggregate firm-wide VaR. The CRO proposes implementation of a stress testing approach to supplement the VaR system. Which of the following statements best supports the CRO's proposal?
A
In practice, stress tests utilize a great number of scenarios while VaR measures rely on just a few scenarios to create their loss estimates.
B
Stress testing makes it possible to capture dependencies between asset classes in specific scenarios that cannot be captured well through a VaR-based system.
C
Stress testing is more accurate than a VaR-based system in predicting the probability of losses at a point in time.
D
While stress testing is similar to VaR, it is restricted to using only distributions of macroeconomic variables to generate its predictions.