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

Under the Fundamental Review of the Trading Book (FRTB) internal models approach, which test determines whether a given risk factor can be included in the expected shortfall model as a modellable risk factor?

A risk factor is modellable only if it passes the risk factor eligibility test, which looks at the number and frequency of real price observations such as transactions or committed quotes. Factors that fail are treated as non-modellable and capitalised separately using stress scenarios.

  1. AThe risk factor must pass a risk factor eligibility test based on the number and frequency of real price observationsCorrect
  2. BThe risk factor must have a correlation above 0.5 with a listed equity index
  3. CThe risk factor must be hedged by a derivative with a central counterparty
  4. DThe risk factor must be approved by the bank's board as strategically important

Explanation

FRTB requires evidence of real price observations (actual transactions or committed quotes) to show a risk factor is modellable. Factors failing the test are non-modellable and are capitalised separately through stress scenarios. The other options are not criteria in the framework.

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