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

A risk manager reviews an EWI whose red threshold is set at the historical 99th percentile of the indicator. Over the past three years it has produced 12 red alerts, but only 1 was followed by an actual liquidity event. What is the primary weakness this evidence indicates, and the appropriate response?

Eleven of twelve red alerts were not followed by stress, a high false-positive rate that risks alert fatigue. The sensible response is to recalibrate the threshold or require confirmation from other indicators. Lowering the threshold would increase false alarms, and slower reporting would reduce timeliness.

  1. AA high false-positive rate; recalibrate the threshold or combine the metric with corroborating indicatorsCorrect
  2. BA high false-negative rate; lower the threshold further
  3. CExcessive data lag; switch to quarterly reporting
  4. DInsufficient escalation; require board approval for every alert

Explanation

Twelve alerts with only one real event means 11 of 12 were false alarms (about 92% false positives), which breeds alert fatigue. The remedy is recalibration or requiring confirmation from other indicators. Lowering the threshold would raise alerts further, and quarterly reporting would worsen timeliness.

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