FRM Part II · FRM Exam Part II · Backtesting VaR
A risk manager at a trading firm explains why the bank backtests its 99% one-day VaR model against daily trading results. Which statement best describes the primary purpose of backtesting?
Backtesting's main purpose is to check that the frequency of losses exceeding VaR matches the model's confidence level. For a 99% VaR, roughly 1% of days should be exceptions. Too many or too few exceptions signals that the model may be misspecified.
- ATo verify that the number of losses exceeding VaR is consistent with the model's stated confidence levelCorrect
- BTo maximise the number of days on which actual losses are below VaR
- CTo calculate the capital charge directly from the observed exceptions without reference to the model
- DTo confirm that the portfolio's expected return is positive over the testing period
Explanation
Backtesting compares realised losses with VaR forecasts to check whether exceptions occur at a frequency consistent with the confidence level. At 99%, about 1% of days should show exceptions. The other options misstate the goal: minimising exceptions is not the aim, and backtesting does not assess expected return.
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