Estimation of Risk Factor Modellability as a Function of Arrival Rate and Seasonality

In its Fundamental Review of the Trading Book (FRTB), the Basel Committee introduces the concept of “non-modellable risk factors” (NMRFs), risk factors which cannot be observed frequently enough in the market to establish an accurate and timely estimate of their value. NMRFs have to be capitalised based on a conservative stress scenario, and their contribution to overall market risk capital can be considerable. An analysis of arrival patterns of market data indicates that the gap condition for non-modellable risk factors (NMRFs) under the FRTB market risk capital requirements is overly conservative and inconsistent with the arrival rate criterion