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

A bank tests an EWI against 20 past episodes. In 8 episodes genuine liquidity stress followed. The indicator breached its trigger before 6 of those 8 stress episodes, and also breached in 3 of the 12 non-stress episodes. Which statement is correct?

The hit rate is 6 of 8 stress episodes, or 75%, and the false alarm rate is 3 of 12 non-stress episodes, or 25%. Using total breaches or the wrong denominator gives different figures that do not measure detection and false alarm rates correctly.

  1. AHit rate 75%, false alarm rate 25% of non-stress episodesCorrect
  2. BHit rate 75%, false alarm rate 50% of non-stress episodes
  3. CHit rate 67%, false alarm rate 25% of non-stress episodes
  4. DHit rate 60%, false alarm rate 20% of non-stress episodes

Explanation

Hit rate is 6/8 = 75% of stress episodes detected. False alarm rate is 3/12 = 25% of non-stress episodes. Option 50% uses 3/6, the wrong base (breaches in stress). Option 67% uses 6/9, the share of breaches that were correct, which is a precision measure rather than the hit rate.

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