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FRM Part II · FRM Exam Part II · Early Warning Indicators

A bank backtests an EWI over 20 historical periods. In 5 periods liquidity stress actually followed. The indicator signaled in 4 of those 5 stress periods, and it also signaled in 6 of the 15 non-stress periods. What are the hit rate (share of stress events signaled) and the false alarm rate (share of non-stress periods with a signal)?

The hit rate is 80% because the indicator signaled in 4 of 5 stress periods. The false alarm rate is 40% because it signaled in 6 of 15 non-stress periods. Using all 20 periods as the base for false alarms would wrongly give 30%.

  1. AHit rate 80%; false alarm rate 40%Correct
  2. BHit rate 80%; false alarm rate 30%
  3. CHit rate 40%; false alarm rate 80%
  4. DHit rate 67%; false alarm rate 40%

Explanation

Hit rate = 4/5 = 80%. False alarm rate = 6/15 = 40%. The 30% figure divides false signals by all 20 periods, which is the wrong base. Option 4 uses 4/6 (precision) as the hit rate and so mixes up the measures.

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