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

A bank's 99%, one-day VaR is 4.0 million. A stress test using a historical crisis scenario shows a one-day loss of 18.0 million. A risk manager argues the VaR model must be defective because the stress loss is 4.5 times VaR. Which response is most appropriate?

The manager is wrong to conclude the model is defective. VaR does not describe losses beyond its confidence level, while stress tests deliberately examine extreme scenarios. A stress loss of 18.0 million versus VaR of 4.0 million is expected tail information that complements VaR, not evidence of failure.

  1. AAgree, since stress loss must never exceed VaR
  2. BDisagree, since stress tests describe losses beyond the VaR confidence level and are not meant to be comparable to VaR; they complement VaR by examining tail eventsCorrect
  3. CAgree, and double the VaR multiplier to 9
  4. DDisagree, since stress losses should always equal 99% VaR by construction

Explanation

VaR says nothing about losses beyond its 1% tail threshold, so an 18.0m crisis loss versus 4.0m (ratio 18/4 = 4.5) is not by itself a model failure. Stress tests are designed to capture such tail and regime-shift events and complement VaR. A ratio alone does not prove defect, and no rule forces equality.

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