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

A bank monitors 20 EWIs using green/amber/red status. Over the past year, 8 times at least one indicator turned red, but only 2 of those were followed by an actual liquidity stress event within three months. Separately, one real stress event occurred with no red indicator beforehand. Based on this history, which conclusion is best supported?

The history shows six of eight red signals were false alarms and one of three stress events was missed. That points to both noise and a coverage gap, so thresholds and the choice of indicators should be reviewed rather than treating the framework as perfect or discarding it.

  1. AThe framework generated many false alarms and also missed an event, so thresholds and indicator selection need reviewCorrect
  2. BThe framework is perfect because 2 of 3 stress events were preceded by red signals
  3. CThe framework has no false positives because every red was investigated
  4. DThe framework should be discarded because it missed one event

Explanation

Of 8 red episodes, 6 were not followed by stress (false positives, 75%). One of 3 stress events (the unsignalled one) was missed, a false negative. Together these show both noise and gaps, pointing to recalibration, not perfection or abandonment.

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