C is correct. It is often more appropriate for stress-testing models to provide a range of possible losses rather than a single estimate.

A is incorrect. While models such as VaR models can be validated using back-testing, there is no similar way of validating the output from a stress test (because stress testing deals with rare events). In this way, the validation of stress-testing models is more difficult than the validation of other models.

B is incorrect. When there are doubts about the best model to use in a certain situation, the results from several models can be compared and the totality of stress-testing reports can make the attendant uncertainties clear.

D is incorrect. Models describing the relationship between variables in normal market conditions (as a model using correlations averaged over a business cycle would) may not describe how they behave in stressed market conditions. Correlations tend to increase in stressed market conditions.

Learning Objective: Describe the role of policies and procedures, validation, and independent review in stress testing governance.

Reference: Global Association of Risk Professionals, Valuation and Risk Models (New York, NY: Pearson, 2023). Chapter 8. Stress Testing [VRM-8]