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FRM Part II · FRM Exam Part II · Fundamental Review of the Trading Book

A bank's internal model computes expected shortfall using liquidity horizons that differ by risk factor category. Under FRTB, what is the purpose of these varying liquidity horizons?

Liquidity horizons reflect how long it would take to exit or hedge a position in stressed conditions without moving the market. FRTB assigns horizons such as 10 to 120 days by risk factor, so that less liquid exposures attract higher capital than a uniform 10-day horizon would give.

  1. ATo reflect the time needed to exit or hedge positions in a stressed market without materially moving pricesCorrect
  2. BTo set the number of days of data used in the backtesting of VaR exceptions
  3. CTo determine the holding period for the stressed capital add-on for non-modellable risk factors
  4. DTo align the ES horizon with the bank's reporting frequency for regulatory returns

Explanation

FRTB embeds market illiquidity by scaling shocks to liquidity horizons (10, 20, 40, 60, 120 days) by risk factor class. This replaces a flat 10-day horizon and addresses the fact that some positions cannot be liquidated quickly. The other options misstate the purpose.

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