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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 VaR using hypothetical (clean) P&L versus actual P&L that includes intraday trading, fees and reserve adjustments. Last year's results were 6 exceptions using actual P&L and 2 using hypothetical P&L. Which interpretation is most appropriate?

Hypothetical P&L isolates model accuracy on a fixed portfolio, so only 2 exceptions there suggests the VaR model is reasonable. The additional actual-P&L exceptions likely arise from intraday activity, fees or reserves, and should be investigated.

  1. AThe model's static-portfolio risk estimation appears sound, and the additional actual-P&L exceptions likely stem from intraday trading, fees or other non-position effects that merit investigationCorrect
  2. BThe model is invalid because actual P&L exceptions are the only meaningful test
  3. CThe model is overly conservative because hypothetical exceptions are fewer
  4. DThe difference proves the hypothetical P&L is miscalculated

Explanation

Hypothetical P&L holds positions fixed, isolating the model's market risk estimation. Extra exceptions in actual P&L point to contamination from intraday trading, fees, commissions or reserves, not necessarily a flawed model. Both comparisons are informative, and the discrepancy should be investigated rather than dismissed.

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