FRM Part II · FRM Exam Part II · Backtesting VaR
A risk manager backtests a 99% one-day VaR model and rejects the model whenever the number of exceptions exceeds a chosen cutoff. In this context, a Type I error occurs when the manager:
A Type I error in VaR backtesting is rejecting a model that is actually correct. The null hypothesis is that the model is accurate, so wrongly rejecting it is a false positive. Accepting a flawed model is the Type II error.
- ARejects a model that is actually accurateCorrect
- BAccepts a model that is actually inaccurate
- CCounts an exception on a day when no loss exceeded VaR
- DFails to record an exception that actually occurred
Explanation
In backtesting, the null hypothesis is that the model is correct. A Type I error is rejecting a correct model; a Type II error is accepting an incorrect one. The second option describes Type II, not Type I.
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