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

A bank's EWI dashboard has produced several amber signals over the past year, none followed by actual liquidity stress. Management proposes eliminating the dashboard. A risk officer instead reviews calibration. Which finding would most strongly indicate that the indicators are poorly calibrated in the sense of too many false positives, rather than being useless?

Thresholds so tight that normal seasonal outflows trigger amber, while the indicators still led the past stress episode, point to false positives from calibration rather than a useless indicator. The remedy is recalibration, such as seasonal adjustment, not elimination. Lagging behaviour would be a different problem.

  1. AThresholds are set so tightly that normal seasonal deposit outflows regularly breach amber, while the indicators did historically move ahead of the one past stress episodeCorrect
  2. BThe indicators moved only after the past stress episode had already begun
  3. CThe dashboard covers both market and internal indicators
  4. DThresholds were approved by the board risk committee

Explanation

Seasonal noise breaching tight thresholds explains frequent false alarms, while leading behaviour in the real stress shows the indicator carries information; the fix is recalibration (for example seasonal adjustment). Option B shows lagging, not false positives. Options C and D are good-practice features, not defects.

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