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FRM Part II · FRM Exam Part II · Estimating Market Risk Measures: An Introduction and Overview

A bank backtests a VaR model and notes that the 95% confidence interval around its 99% VaR estimate is very wide. Which interpretation is most appropriate for the risk committee?

A wide confidence interval signals substantial sampling uncertainty in the VaR estimate, not bias or conservatism. The committee should treat the point estimate with caution and allow for the imprecision when setting limits or capital, and consider more data or tail-modelling methods.

  1. AThe VaR estimate is biased and should be replaced by the lower bound of the interval
  2. BThe estimate is subject to substantial sampling uncertainty, so decisions such as limit setting should allow for this imprecisionCorrect
  3. CThe model must be correct, since wide intervals show conservative risk estimates
  4. DThe confidence level should be lowered to 50% to make the interval exactly zero width

Explanation

A wide interval reflects sampling error, typically from a small sample or tail scarcity, not bias or conservatism. Users should treat the point estimate cautiously, for instance by using more data or a more robust method, and allow for the uncertainty in limits.

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