FRM Part II · FRM Exam Part II · Validating Bank Holding Companies' Value-at-Risk Models for Market Risk
A bank's trading desk shows four VaR exceptions in the last 250 days, but three of them occurred on consecutive days during a single market shock. What is the most appropriate conclusion about the exceptions' pattern?
Clustered exceptions indicate that the exceptions are not independent, so the model likely reacts too slowly to rising volatility. Even if the total count looks acceptable, an independence or conditional coverage test would flag the model as deficient.
- AThe clustering suggests the VaR model fails to adapt to changing volatility, indicating a violation of independenceCorrect
- BThe clustering is consistent with a correctly specified model because exceptions must be independent over time
- CThe clustering shows the model is overly conservative
- DThe clustering is irrelevant because only the total count matters in backtesting
Explanation
A correct VaR model should produce exceptions that are independent over time. Consecutive exceptions suggest slow response to volatility changes, which a conditional coverage or independence test would detect. Total count alone ignores this weakness.
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