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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 risk committee notes that its VaR model, calibrated on a calm period, shows low risk, while a stress test using the 2008 crisis scenario produces a loss several times larger than VaR. What is the most appropriate conclusion?

Stress testing complements VaR. A VaR model calibrated on calm data may not capture extreme regimes, while a crisis scenario shows plausible tail losses. Both should be used together; neither replaces the other, and a stress loss exceeding VaR is expected.

  1. AVaR is flawed and should be discontinued in favor of stress testing only
  2. BStress testing complements VaR by capturing extreme, low-probability events the VaR calibration may not reflectCorrect
  3. CThe stress test is invalid because it exceeds VaR
  4. DThe VaR confidence level should be lowered to match the stress loss

Explanation

VaR depends on the historical window and confidence level and says little about losses beyond the quantile or in regimes absent from the data. Stress tests cover such scenarios, so the two are complements. A loss exceeding VaR does not invalidate the stress test.

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