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

A risk manager at a bank holding company observes 8 exceptions in 250 days for a 99% one-day VaR model. Using the Basel traffic-light zones (green 0-4, yellow 5-9, red 10 or more), what is the most appropriate conclusion?

Eight exceptions out of 250 sits in the yellow zone. Results there are ambiguous, so the model is not automatically rejected, but supervisors can raise the capital multiplier, depending on the cause. Too many exceptions suggests risk may be underestimated rather than overestimated.

  1. AGreen zone; the model is accepted with no change in the capital multiplier
  2. BYellow zone; the model may be inaccurate and the supervisor may increase the capital multiplierCorrect
  3. CRed zone; the model is automatically rejected
  4. DYellow zone; the multiplier is cut because the model is conservative

Explanation

Eight exceptions falls in the yellow zone (5-9). Here the model is not automatically rejected, but supervisors may add to the multiplier, with discretion depending on the cause. The red zone begins at 10, and more exceptions than expected implies underestimated risk, not conservatism.

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