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

Which is a recognised limitation of relying on a set of early warning indicators as the sole liquidity monitoring tool?

A key limitation is that indicators may miss rapid, idiosyncratic or unprecedented stress, such as a sudden confidence-driven run, because they rest on historical relationships and chosen metrics. They should complement stress testing and contingency planning rather than serve as the sole monitoring tool.

  1. AIndicators cannot be quantified
  2. BIndicators may fail to capture rapid, idiosyncratic or unprecedented stress, such as a sudden loss of confidence driven by social mediaCorrect
  3. CIndicators are prohibited from being used with stress testing
  4. DIndicators always generate too few alerts

Explanation

EWIs are based on historical relationships and chosen metrics, so they may miss fast-moving or novel events. They complement, not replace, stress testing and the contingency funding plan. Many indicators are quantifiable and they are used alongside stress tests.

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