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FRM Part II · FRM Exam Part II · Backtesting VaR

A bank's backtesting shows 11 exceptions over 250 days at 99% confidence. The bank claims all were caused by a single market event. Under the Basel traffic light approach, what is the most appropriate conclusion?

Eleven exceptions in 250 days falls in the red zone (10 or more). The multiplier increase to 4.0 is generally automatic, and the model is presumed inaccurate and should be reviewed and improved. A single causal event does not reduce the count of daily exceptions.

  1. AThe model is in the yellow zone, and the supervisor may choose any multiplier increment
  2. BThe model is in the red zone; the increase in the multiplier is generally automatic and the model should be reviewed and improvedCorrect
  3. CThe model is in the green zone because a single event counts as one exception
  4. DThe model is in the red zone, but the multiplier is unchanged if the cause is a single event

Explanation

Ten or more exceptions in 250 days is the red zone. In this zone the framework calls for an automatic increase of the multiplier to 4.0 and a presumption that the model is inaccurate, so it needs to be reviewed. Counting exceptions follows daily losses exceeding VaR, not the number of underlying events.

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