Module: | MODULE B: RISK MANAGEMENT
Q270: Consider the following statements regarding the standard risk measurement models utilized in a basic risk management framework:
1. Value at Risk (VaR) measures the maximum expected financial loss over a defined target horizon within a specific statistical confidence interval.
2. Sensitivity analysis is exclusively utilized to evaluate the impact of simultaneous, extreme macroeconomic shocks across the entire consolidated banking portfolio.
3. Stress testing is utilized by banks to measure their vulnerability to extreme, low-probability tail-risk events that fall entirely outside normal statistical expectations.
Which of the statements given above is/are correct?
2. Sensitivity analysis is exclusively utilized to evaluate the impact of simultaneous, extreme macroeconomic shocks across the entire consolidated banking portfolio.
3. Stress testing is utilized by banks to measure their vulnerability to extreme, low-probability tail-risk events that fall entirely outside normal statistical expectations.
Which of the statements given above is/are correct?
✅ Correct Answer: C
The correct answer is C. Statement 1 is correct: Value at Risk (VaR) is the industry-standard statistical measure for market risk.
It calculates the maximum potential loss in the value of a portfolio over a defined period (e.g., 1 day or 10 days) for a given confidence interval (e.g., 95% or 99%). Statement 2 is incorrect: Sensitivity analysis generally measures the impact of a change in a *single* parameter (like a 100 bps shift in interest rates) on the portfolio's value, keeping all other variables constant.
Evaluating simultaneous, extreme macroeconomic shocks across the entire portfolio is the definition of "Scenario Analysis" or "Macro Stress Testing," not basic sensitivity analysis.
Statement 3 is correct: Stress testing is explicitly designed to measure "tail risks"—extreme, highly abnormal, low-probability events (like the 2008 financial crisis or a global pandemic) that VaR models fail to capture because they fall outside normal statistical bell-curve expectations.
It calculates the maximum potential loss in the value of a portfolio over a defined period (e.g., 1 day or 10 days) for a given confidence interval (e.g., 95% or 99%). Statement 2 is incorrect: Sensitivity analysis generally measures the impact of a change in a *single* parameter (like a 100 bps shift in interest rates) on the portfolio's value, keeping all other variables constant.
Evaluating simultaneous, extreme macroeconomic shocks across the entire portfolio is the definition of "Scenario Analysis" or "Macro Stress Testing," not basic sensitivity analysis.
Statement 3 is correct: Stress testing is explicitly designed to measure "tail risks"—extreme, highly abnormal, low-probability events (like the 2008 financial crisis or a global pandemic) that VaR models fail to capture because they fall outside normal statistical bell-curve expectations.