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FRM Part II · FRM Exam Part II · Fundamental Review of the Trading Book

Under FRTB, how must a risk factor that fails the modellability assessment (a non-modellable risk factor) be treated in the internal models approach?

A non-modellable risk factor is removed from the ES model and capitalised separately through a stress scenario capital add-on. This ensures that factors with too few real price observations still attract a conservative charge rather than escaping capital altogether.

  1. AIt is capitalised through a separate stress scenario capital add-onCorrect
  2. BIt is included in ES using the average of the last 60 days of prices
  3. CIt is excluded from capital because it lacks sufficient data
  4. DIt is mapped to the nearest modellable factor with no additional charge

Explanation

Risk factors lacking enough observable real prices are non-modellable and are excluded from ES. They are instead covered by a stressed expected shortfall add-on, the stress scenario risk measure, calibrated to a period of stress. Excluding them without charge would understate risk.

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