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FRM Part II · FRM Exam Part II · Validating Bank Holding Companies' Value-at-Risk Models for Market Risk

A risk analyst compares daily 99% VaR with next-day P&L over 250 days and finds 7 exceptions. Under the Basel traffic-light framework, in which zone does the model fall and what is the consequence?

Seven exceptions in 250 days places the model in the yellow zone (5 to 9 exceptions). Supervisors may raise the capital multiplier with an add-on that increases with the exception count, but the model is not automatically rejected as it would be in the red zone.

  1. AGreen zone; no increase in the multiplier
  2. BYellow zone; supervisor may increase the multiplier by an add-onCorrect
  3. CRed zone; the multiplier add-on is automatic and the model is presumed flawed
  4. DYellow zone; the model must be immediately withdrawn

Explanation

Green is 0-4 exceptions, yellow is 5-9, red is 10 or more. Seven exceptions is yellow, where the capital multiplier add-on is discretionary and scaled to the count, not automatic. Withdrawal is not required in the yellow zone.

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