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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 trading desk shows more exceptions when VaR is compared with actual (clean-plus-dirty) P&L than with hypothetical P&L. Which is the most likely explanation?

Actual P&L is contaminated by items such as fees, commissions and intraday trading gains or losses that a static end-of-day-portfolio VaR does not cover. Hypothetical P&L holds positions constant, so it isolates model performance and generally gives cleaner exception counts.

  1. AHypothetical P&L includes intraday trading and fees
  2. BActual P&L includes fees, commissions and intraday trading results that the static-portfolio VaR does not captureCorrect
  3. CActual P&L holds the portfolio constant for the horizon
  4. DHypothetical P&L is based on a longer holding period

Explanation

Actual P&L includes intraday trading, fees, commissions and reserve changes, which are not in VaR based on the end-of-day portfolio. Hypothetical P&L holds positions fixed, isolating the model's market risk. Thus the contamination affects actual P&L and can raise or distort exception counts.

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