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

During a liquidity stress test review, a risk manager notices that the model assumes the bank can roll over 90% of its maturing wholesale funding in a severe idiosyncratic scenario, based on rollover rates observed over the past five years of benign markets. What is the most appropriate criticism?

The assumption is flawed because it uses benign-period rollover rates for a severe idiosyncratic scenario. In such an event, counterparties cut lines and market access shrinks, so rollover would be much lower. Stress assumptions should reflect adverse behavior, using judgment and stressed historical episodes rather than calm-period averages.

  1. AThe assumption is conservative because rollover rates are always lower in benign markets than in stress
  2. BThe assumption relies on calm-period behavior that does not reflect the reduced market access and counterparty reactions in a severe idiosyncratic eventCorrect
  3. CThe assumption is appropriate because historical data is the only valid source for behavioral parameters
  4. DThe assumption should be replaced by contractual maturities, which assume full rollover

Explanation

Behavioral parameters must reflect stress conditions, including loss of market access and counterparties pulling lines in an idiosyncratic event. Benign-period rollover rates overstate funding availability. Contractual maturities mean no automatic rollover, so the last option is wrong too.

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