The profit-and-loss attribution test is one of two regulator-set tests that a bank’s trading desk must pass in order to use the internal models approach for market risk capital calculations. The test compares two measures: the hypothetical P&L generated by the desk’s front-office pricing models, and the risk-theoretical P&L generated by the bank’s own risk models. The gap between the two P&Ls is measured using a mean ratio as well as a variance ratio. The ratios generated from the two P&Ls must remain within established thresholds for the test to be validated. A breach occurs if the desk surpasses the threshold. Four breaches within a 12-month period constitutes a failure, which could force the trading desk back on to the standardised approach.
P&L ATTRIBUTION TEST
