Skip to content

FRM Part II · FRM Exam Part II · Credit Value at Risk

A bank's credit VaR model produces a 99.9% one-year loss of 180 million on a portfolio with expected loss of 40 million. A validator replaces the model's assumed average recovery with a downturn-correlated recovery, raising the 99.9% loss to 215 million while expected loss rises to 46 million. What is the change in unexpected loss at 99.9%, and what does it indicate?

Unexpected loss rises by 29 million, from 140 million (180 minus 40) to 169 million (215 minus 46). This indicates the original model understated tail risk by ignoring the negative correlation between recovery rates and default in downturns.

  1. A35 million increase, showing recovery-default correlation was ignored
  2. B29 million increase, showing recovery-default correlation was ignoredCorrect
  3. C35 million increase, showing recoveries were overstated only in expected loss
  4. D29 million decrease, showing the original model was conservative

Explanation

Original UL = 180 - 40 = 140. Revised UL = 215 - 46 = 169. Change = 29 million increase. The 35 million figure ignores the rise in expected loss. The increase shows tail loss was understated by assuming recovery independent of default conditions.

Did you get it right without looking?

One question tells you little. A timed set on Credit Value at Risk shows your real accuracy, how long you take and where you lose marks.

Practise Credit Value at RiskFree diagnostic mock

More Credit Value at Risk questions