CORES Scenario Analysis & Stress Testing 3 — Questions and Answers
Question 1: A systemic cyber-attack simultaneously disables payment processing at three large financial institutions. This type of scenario is BEST classified as:
- Idiosyncratic operational risk
- Systemic correlated stress scenario (Correct answer)
- Single-factor sensitivity test
- Reverse stress test
Correct answer: Systemic correlated stress scenario
Simultaneous impact on multiple institutions from a common threat represents a systemic, correlated stress scenario rather than a firm-specific event.
Question 2: Under the Basel III framework, what role does the Loss Distribution Approach (LDA) play in relation to scenario analysis?
- LDA replaces scenario analysis for all AMA banks
- Scenario analysis supplements LDA by capturing low-frequency, high-severity tail events (Correct answer)
- LDA is used only for market risk, not operational risk
- Scenario analysis is applied first, then LDA refines the output
Correct answer: Scenario analysis supplements LDA by capturing low-frequency, high-severity tail events
LDA relies on historical loss data and may underestimate rare catastrophic events, so scenario analysis fills this gap for the tail of the distribution.
Question 3: A firm conducts a geopolitical stress test assuming a major trade war. Which operational risk sub-category is MOST directly activated?
- Internal fraud
- External fraud and clients/products/business practices
- Business disruption and system failures through supply chain impacts (Correct answer)
- Employment practices and workplace safety
Correct answer: Business disruption and system failures through supply chain impacts
Trade wars typically disrupt supply chains and third-party services, most directly triggering business disruption and system failure operational risk categories.
Question 4: Which statistical technique is MOST commonly used to model the aggregate loss distribution when combining frequency and severity in a stress scenario?
- Linear regression
- Monte Carlo simulation (Correct answer)
- Exponential smoothing
- Principal component analysis
Correct answer: Monte Carlo simulation
Monte Carlo simulation generates thousands of combined frequency and severity draws to estimate the full aggregate loss distribution under stress.
Question 5: A risk manager notices that scenario assumptions created two years ago no longer reflect the firm's current risk profile. What action should be taken FIRST?
- Archive the old scenarios and start fresh with all-new assumptions
- Conduct a formal scenario refresh process reviewing assumptions against current business and environment (Correct answer)
- Continue using existing scenarios to maintain comparability over time
- Escalate immediately to the board that capital may be understated
Correct answer: Conduct a formal scenario refresh process reviewing assumptions against current business and environment
A structured scenario refresh that reassesses assumptions against current conditions is the appropriate first step before any capital or reporting conclusions are drawn.
Question 6: In a multi-year capital stress test, what does 'capital depletion analysis' specifically measure?
- The speed at which a bank's stock price declines
- The trajectory of capital ratios through the stress horizon as losses accumulate (Correct answer)
- The percentage of assets that become non-performing
- The reduction in regulatory capital requirements over time
Correct answer: The trajectory of capital ratios through the stress horizon as losses accumulate
Capital depletion analysis tracks how stress losses erode capital ratios period by period across the test horizon, identifying when minimums may be breached.
Question 7: Which element distinguishes a 'narrative-driven' scenario from a purely quantitative shock scenario?
- Narrative scenarios never assign numerical loss estimates
- Narrative scenarios anchor quantitative parameters in a coherent causal story of how the event unfolds (Correct answer)
- Narrative scenarios are used exclusively for regulatory submissions
- Narrative scenarios require external validation by a third party
Correct answer: Narrative scenarios anchor quantitative parameters in a coherent causal story of how the event unfolds
Narrative scenarios provide a logical sequence of events that contextualizes and justifies the quantitative assumptions, improving plausibility and stakeholder understanding.
CORES Scenario Analysis & Stress Testing 3
A systemic cyber-attack simultaneously disables payment processing at three large financial institutions.
This type of scenario is BEST classified as: