FRM Part II · FRM Exam Part II · Backtesting VaR
A risk manager finds that a bank's VaR exceptions cluster in consecutive days during volatile periods, while the model uses an equally weighted 500-day historical window. Which model improvement most directly addresses the cause?
Adopt a volatility-weighted or exponentially weighted approach. Clustered exceptions indicate the equally weighted window adapts too slowly when volatility rises. Giving recent data more influence lets VaR rise promptly in turbulent periods. Lengthening the window or changing the confidence level does not fix the slow adaptation.
- AIncrease the window to 1,000 days with equal weights
- BSwitch to a volatility-weighted or exponentially weighted approach that adapts faster to changing volatilityCorrect
- CReduce the confidence level from 99% to 95% to cut exceptions
- DReport VaR only weekly
Explanation
Clustering shows the model reacts slowly to volatility regime changes. Weighting recent observations more heavily or scaling by current volatility makes VaR respond faster. A longer equal-weighted window makes it even slower, and changing the confidence level merely changes the target rather than fixing the cause.
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