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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 one-day 99% VaR model over 250 trading days and records 9 exceptions. Under the Basel traffic-light framework, which zone does this fall into, and what is the consequence?

Nine exceptions in 250 days at 99% VaR is in the yellow zone (5-9 exceptions). The capital multiplier add-on increases, but the model is not automatically rejected. Automatic presumption of inaccuracy applies only in the red zone, which begins at 10 exceptions.

  1. AGreen zone; no increase in the capital multiplier
  2. BYellow zone; the multiplier increases and the model is not automatically rejectedCorrect
  3. CRed zone; the model is automatically deemed inaccurate
  4. DYellow zone; the model is automatically rejected and must be rebuilt

Explanation

Under the Basel traffic-light approach for 250 observations at 99%, 0-4 exceptions is green, 5-9 yellow and 10 or more red. Nine exceptions is yellow, which raises the multiplier add-on at supervisory discretion rather than automatically rejecting the model. The red zone starts at 10, so option C is wrong.

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