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FRM Part II · FRM Exam Part II · Integrated Risk Management

In a top-down risk integration framework, a bank first aggregates risks within each risk type and then across risk types. Which is a recognised weakness of this approach compared with a bottom-up (fully integrated) approach?

A top-down approach measures each risk type separately and then combines them, so it can miss interactions among underlying risk drivers across risk types, such as a market shock feeding into credit losses. Bottom-up integration captures these links but is far more complex to build.

  1. AIt may miss interactions among risk drivers across risk types, such as a market shock increasing credit lossesCorrect
  2. BIt cannot produce a single capital number
  3. CIt requires full simulation of every position in the bank
  4. DIt ignores the differing confidence levels used within each risk type

Explanation

Top-down aggregation combines separately measured risk types using correlations or copulas, so it can overlook common drivers that link losses (for example rates rising affecting both market and credit). Bottom-up models capture these interactions but are more complex. Top-down does yield a single number and is less computationally heavy.

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