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

A bank backtests an EWI over 40 historical months. The indicator reached its red trigger in 10 months. Actual liquidity stress events occurred in 8 months, and the red trigger preceded 6 of them. Which statement about the indicator's performance is correct?

Precision is 60% and the capture rate is 75%. Six of the ten red signals were followed by stress, giving 60%, while six of the eight actual stress events were preceded by a red signal, giving 75%. Swapping the denominators would reverse the two figures.

  1. APrecision of red signals is 60% and the share of stress events captured is 75%Correct
  2. BPrecision of red signals is 75% and the share of stress events captured is 60%
  3. CPrecision of red signals is 60% and the share of stress events captured is 60%
  4. DPrecision of red signals is 6% and the share of stress events captured is 75%

Explanation

Of 10 red signals, 6 were followed by stress, so the hit rate is 6/10 = 60%. Of 8 stress events, 6 were preceded by a red signal, so capture is 6/8 = 75%. The second option swaps the two ratios. The 6% option miscomputes the ratio.

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