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

A bank validation team compares its internal VaR model against an independent benchmark model built with different methodology and data on the same trading portfolio. Which statement best describes the primary purpose of this benchmarking exercise?

Benchmarking compares the VaR model to an independent alternative to see whether results differ materially. Large unexplained gaps point to possible weaknesses in assumptions, data or implementation. It supplements backtesting, does not replace it, and cannot prove the model is exactly right.

  1. ATo replace backtesting by showing the model has zero exceptions
  2. BTo identify whether the model's outputs differ materially from an alternative, which may signal weaknesses in assumptions or implementationCorrect
  3. CTo guarantee that the model produces the lowest possible capital requirement
  4. DTo prove that the model's distributional assumption is exactly correct

Explanation

Benchmarking compares model results with those of an alternative model or approach. Large unexplained differences prompt investigation into assumptions, data or implementation. It complements rather than replaces backtesting, and it cannot prove a model is correct.

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