Why FRTB model test loves volatility, but hates hedges
Crucial P&L test for internal models easier to pass if price swings are large, or desks poorly hedged
Bankers might flinch at the very mention of its name. The profit-and-loss attribution (PLA) test, part of the Basel Committee on Banking Supervision’s trading book capital rules, is a vital hoop trading desks must jump through to benefit from lighter capital requirements.
The PLA test is the gateway to using internal models for market risk capital calculations, instead of a tougher regulator-set sensitivities-based approach (SBA). But bank simulations suggest the test is difficult to pass
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