FRM Part II · FRM Exam Part II · Risk Identification
A bank's internal loss database only records events with gross loss above USD 50,000. A risk manager fitting a severity distribution to this data without adjustment is most likely to encounter which bias?
A reporting threshold truncates the data from below, so observed frequency is understated and the average severity is overstated because small losses are absent. Analysts should fit truncated distributions or otherwise adjust for the threshold rather than treating the sample as complete.
- AUnderstated frequency and overstated average severity because small losses are missing from the sampleCorrect
- BOverstated frequency and understated average severity
- CNo bias, since large losses dominate capital
- DBias only in the correlation between business lines
Explanation
A collection threshold truncates the data from below. Observed counts understate true frequency of all events, and the sample mean severity is biased upward since small losses are excluded. Models must account for truncation, for example using conditional (shifted or truncated) distributions.
Did you get it right without looking?
One question tells you little. A timed set on Risk Identification shows your real accuracy, how long you take and where you lose marks.
More Risk Identification questions
- A bank's operational risk function is building a taxonomy to classify loss events consistently across business lines. Which of the following…
- A bank's operational risk team wants an indicator that signals rising risk exposure before losses are recorded in the loss database. Which o…
- A bank defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems, or from exte…
- An operational risk analyst builds an internal loss database. A fraud event is discovered in 2024, but the fraudulent activity occurred in 2…
- An operational risk manager wants to identify emerging risks that may not yet appear in the bank's loss data or risk taxonomy. Which approac…
- A bank's RCSA scores likelihood and impact on a 1-5 scale and multiplies them to give an inherent score. A control is rated as reducing the …