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

A bank holding company wants to assess its internal VaR model by comparing its output with an independent measure. It runs the same trading portfolio through a vendor model and a separate historical-simulation model built by a validation team. Which description best captures the purpose of this exercise?

This is benchmarking: the validation compares the internal VaR model's output with an independent or alternative model on the same portfolio to check whether results are broadly consistent. It differs from backtesting, which compares VaR with realized profit and loss and counts exceptions.

  1. ABenchmarking, which compares the model's results with those of an alternative model or independent estimate to see whether they are broadly consistentCorrect
  2. BBacktesting, which counts the days on which actual losses exceeded the reported VaR
  3. CStress testing, which applies extreme but plausible scenarios to the portfolio
  4. DMapping, which assigns positions to a limited set of risk factors

Explanation

Benchmarking compares model output against an alternative model or independent estimate. Backtesting instead compares VaR to realized P&L outcomes. Running the same portfolio through a second model is a comparison of models, not a count of exceptions or a scenario shock.

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