FRM Part I · FRM Exam Part I · Hypothesis Testing
A risk manager backtests a 95% VaR model over 500 days. The model produced 35 exceptions. Using a two-tailed z-test at the 5% significance level (critical value 1.96) with the normal approximation, which conclusion is correct?
Not determinable from the options.
- AReject the model, because z is about 2.30
- BReject the model, because z is about 1.03
- CDo not reject the model, because z is about 1.03Correct
- DDo not reject the model, because z is about 2.30
Explanation
Expected exceptions = 500 x 0.05 = 25. Standard deviation = sqrt(500 x 0.05 x 0.95) = sqrt(23.75) = 4.873. z = (35 - 25)/4.873 = 2.05. This exceeds 1.96, so the model is rejected; the listed options are therefore mismatched, and none of them is correct as written.
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