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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's validation team reviews a VaR model that uses a one-year window of daily historical data and finds that the data for several thinly traded corporate bonds are often stale, with prices repeated from prior days. Which is the most likely effect of this data problem on the VaR estimate?

VaR is most likely understated. Stale prices create runs of zero returns and delayed catch-up moves, which suppress measured volatility and weaken measured correlation with market risk factors, so the model underestimates the true potential loss.

  1. AVaR is understated because stale prices understate return volatility and correlation with market factorsCorrect
  2. BVaR is overstated because repeated prices create artificial large price jumps
  3. CVaR is unaffected because stale prices only change the mean of returns
  4. DVaR is overstated because stale prices raise measured correlations across assets

Explanation

Repeated prices produce zero returns followed by catch-up jumps, which dampens measured daily volatility and breaks the link to common risk factors. The result is an understated VaR. The claim that VaR is overstated ignores the smoothing effect of stale pricing.

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