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

Over 20 quarters, a bank's liquidity EWI generated 8 red signals. Of these, 2 were followed by an actual liquidity stress event. In the same period 3 stress events occurred in total. Which statement correctly assesses the indicator?

The hit rate is 25% (2 of 8 signals preceded stress), while the indicator caught 2 of 3 events and missed one. High false alarms and a miss point to recalibrating thresholds and adding complementary indicators, rather than discarding it or treating 67% as signal reliability.

  1. AHit rate (signals followed by stress) is 25%, and it missed 1 of 3 events, so false alarms are a major limitation and thresholds should be recalibratedCorrect
  2. BHit rate is 67% and false alarms are not a concern
  3. CHit rate is 25%, but this proves the indicator is ineffective and should be discarded
  4. DHit rate is 2 of 3 events, equal to 67%, so signals are reliable predictors

Explanation

Precision = 2/8 = 25%, so 6 of 8 signals were false alarms. Detection rate = 2/3 = 67%, with 1 event missed. Both false positives and a missed event suggest recalibrating thresholds and supplementing with other indicators, not discarding outright. The 67% figure is recall, not signal reliability.

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