FRM Part II · FRM Exam Part II · Backtesting VaR

A risk manager finds that a bank's 99% VaR had 4 exceptions in 250 days, all occurring within a single two-week period of market stress, and that exceptions were followed by further exceptions the next day. What is the most appropriate conclusion and model improvement?

Clustered exceptions indicate the independence property is violated, usually because the model reacts slowly to volatility shifts. The appropriate improvement is a more adaptive volatility estimate, such as a shorter window or exponential weighting, rather than merely accepting the acceptable total count or changing confidence level.

1. AThe exceptions are independent, so no change is needed because the total count is acceptable
2. BThe model likely responds too slowly to changes in volatility; consider a more adaptive volatility estimate such as a shorter window or exponential weightingCorrect
3. CThe confidence level should be lowered to 95% so fewer exceptions occur
4. DThe holding period should be lengthened to ten days to absorb the stress