FRM Part II · FRM Exam Part II · Backtesting VaR
A bank's 99% one-day VaR is backtested over 250 days. Investigation of 7 exceptions shows that the trading desk's reported P&L included fees, commissions and intraday reserve adjustments, while the VaR model measures only price changes on static positions. Which action best improves the backtest?
The best fix is to backtest against hypothetical, or clean, P&L that holds positions constant and excludes fees, commissions and reserve adjustments. The exceptions arose from comparing VaR with a P&L measure containing items the model does not capture, so aligning the P&L definition corrects the problem.
- ABacktest against hypothetical (clean) P&L that holds positions fixed and removes fees and non-market itemsCorrect
- BIncrease the VaR multiplier used for capital without changing the P&L definition
- CSwitch from historical simulation to a parametric normal model
- DReduce the sample to the most recent 60 days
Explanation
The inconsistency is between the P&L being compared with VaR and the risk the model measures. Using hypothetical P&L with fixed positions and excluding fees and reserves aligns the comparison. A larger multiplier merely raises capital, and changing the model or sample does not fix a contaminated P&L series.
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