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

A bank's regulator compares Basel 2.5 with FRTB. Under Basel 2.5 the bank used 10-day 99% VaR, stressed VaR, IRC and a comprehensive risk measure. Which of the following correctly describes how FRTB's internal models approach changes the core risk metric and treatment of liquidity?

FRTB's internal models approach uses 97.5% expected shortfall calibrated to stress, with liquidity horizons from 10 to 120 days assigned to risk factors. This replaces Basel 2.5's 99% VaR and stressed VaR, which assumed a constant 10-day horizon and so ignored differences in market liquidity.

  1. AIt uses 97.5% expected shortfall with liquidity horizons of 10 to 120 days applied to risk factors, replacing the 99% VaR and stressed VaRCorrect
  2. BIt uses 99% VaR with a constant 10-day horizon for all risk factors, retaining stressed VaR
  3. CIt uses 99.9% VaR over one year and removes liquidity considerations
  4. DIt uses 97.5% expected shortfall with a constant one-day horizon for all risk factors

Explanation

FRTB replaces VaR and stressed VaR with expected shortfall calibrated to a period of stress at 97.5%, and embeds varying liquidity horizons (10, 20, 40, 60, 120 days) by risk factor. This addresses the Basel 2.5 flaw of a constant 10-day horizon regardless of liquidity. The other options keep VaR or drop liquidity.

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