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FRM Part II · FRM Exam Part II · Estimating Market Risk Measures: An Introduction and Overview

A risk manager considers raising the VaR confidence level from 95% to 99% while keeping the holding period and the normal-distribution model unchanged. What is the most direct effect on the reported VaR and on backtesting?

Raising confidence from 95% to 99% increases VaR because the cutoff moves further into the tail, and exceptions should occur only about 1% of days. With so few expected breaches, backtesting has less statistical power to detect a poor model.

  1. AVaR rises, and exceptions become rarer, so backtests have less statistical power to detect a flawed modelCorrect
  2. BVaR falls, because fewer observations lie beyond the cutoff
  3. CVaR is unchanged, but expected shortfall increases
  4. DVaR rises, and exceptions become more frequent in a correct model

Explanation

A higher confidence level moves the cutoff further into the tail, so VaR increases (z from 1.645 to 2.326). A correct model then expects only 1% exceptions rather than 5%, so there are fewer breaches to observe and backtests have lower power. Exceptions becoming more frequent is wrong.

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