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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 (IMA), which of the following best describes the purpose of the risk factor eligibility (modellability) test?

The modellability test checks whether a risk factor has sufficient real price observations. Modellable factors go into the expected shortfall model, while non-modellable factors are capitalised separately through stress scenarios. P&L attribution, backtesting and liquidity horizons are separate requirements.

  1. ATo determine whether each risk factor has enough real price observations to be included in the expected shortfall model rather than capitalised through stressed scenariosCorrect
  2. BTo determine whether a trading desk's hypothetical P&L is consistent with its risk-theoretical P&L
  3. CTo count the number of daily VaR exceptions at the bank level over the last 250 days
  4. DTo set the liquidity horizon applicable to each risk factor category

Explanation

The modellability test checks whether observable prices from real transactions or committed quotes are sufficient for a risk factor. Factors that pass enter the ES model; those that fail are capitalised separately via the stress scenario capital add-on (SES). The other options describe P&L attribution, backtesting, and liquidity horizons.

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