FRM Part II · FRM Exam Part II · Backtesting VaR
A risk committee reviews a 99% one-day VaR model that showed 6 exceptions in 250 days. Which statement about the Type 1 and Type 2 errors in this backtest is most accurate?
Rejecting a correct model is a Type 1 error, and accepting an incorrect model is a Type 2 error. Making the rejection threshold stricter lowers Type 1 errors but increases Type 2 errors, so a backtest must balance the two rather than minimize one.
- ARejecting a correct model is a Type 2 error, and tightening the rejection threshold reduces it
- BAccepting an incorrect model is a Type 1 error, and it is controlled directly by the chosen confidence level
- CLowering the VaR confidence level makes exceptions more frequent and removes the need to balance both error types
- DRejecting a correct model is a Type 1 error, and a stricter rejection threshold lowers Type 1 but raises Type 2 errorsCorrect
Explanation
Type 1 error is rejecting a correct model; Type 2 is accepting an incorrect one. A stricter threshold (more exceptions needed to reject) reduces Type 1 errors but makes Type 2 errors more likely. The other options swap the definitions or ignore the trade-off.
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