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FRM Part II · FRM Exam Part II · Liquidity Stress Testing

A treasury team uses a cash flow projection model with behavioral assumptions for non-maturity deposits. Which practice best strengthens the credibility of those assumptions for stress testing?

The best practice is to back-test behavioral assumptions against historical outflow data and then add severe-but-plausible stress overlays. Stable-period averages understate stressed behavior, and adopting peer assumptions without validation ignores the bank's own depositor base and product features.

  1. ABack-test the assumptions against historical outflow experience and adjust them with severe-but-plausible overlays for stressCorrect
  2. BUse contractual maturity of zero days for all non-maturity deposits and avoid any modeling
  3. CSet run-off equal to the average outflow observed during stable periods only
  4. DAdopt the assumptions used by peer banks without internal validation

Explanation

Behavioral assumptions should be grounded in data and then stressed beyond normal experience, with governance and validation. Stable-period averages understate stress outflows, and copying peers ignores bank-specific features.

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