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FRM Part II · FRM Exam Part II · Validating Bank Holding Companies' Value-at-Risk Models for Market Risk

A bank backtests its 99% one-day VaR over 250 trading days and records 7 exceptions. Under the Basel traffic-light framework, in which zone does the model fall?

The model is in the yellow zone. For 250 days of 99% VaR, Basel treats 0 to 4 exceptions as green, 5 to 9 as yellow and 10 or more as red, so seven exceptions is yellow and attracts a higher capital multiplier.

  1. AGreen zone, because the expected number of exceptions is 2.5
  2. BYellow zone, because exceptions fall in the range of 5 to 9Correct
  3. CRed zone, because exceptions exceed the expected number
  4. DYellow zone, because exceptions fall in the range of 10 to 14

Explanation

Under the Basel traffic-light approach for 250 observations at 99%, 0-4 exceptions is green, 5-9 is yellow, and 10 or more is red. Seven exceptions is therefore yellow. The red-zone option is wrong because red begins at 10 exceptions, not merely above the expected 2.5.

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