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CMA Final · Risk Management in Banking and Insurance · Market Risk Management

A bank's 99% one-day VaR is estimated at Rs 10 crore. Over the last 250 trading days, backtesting shows 7 days on which actual losses exceeded VaR. Under the Basel backtesting traffic-light approach (green zone 0-4 exceptions, yellow 5-9, red 10 or more), what is the correct conclusion?

The result falls in the yellow zone, because seven exceptions lie between five and nine. The model warrants scrutiny and supervisors may raise the capital multiplier above the base level of three. It is neither green nor an automatic red-zone rejection, and the multiplier is not reduced.

  1. AGreen zone; no increase in the multiplier
  2. BRed zone; model automatically rejected
  3. CYellow zone; the model may need scrutiny and a higher multiplication factor may applyCorrect
  4. DYellow zone; the multiplier is reduced below 3

Explanation

Seven exceptions fall in the yellow zone (5-9). This signals possible model weakness and supervisors may add to the capital multiplier above the base of 3. The multiplier is never reduced in the yellow zone, and red-zone treatment needs 10 or more exceptions. Expected exceptions at 99% over 250 days are about 2.5.

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