Skip to content

FRM Part II · FRM Exam Part II · Beyond Exceedance-Based Backtesting of Value-at-Risk Models

A risk team backtests a 99% one-day VaR model using only the count of exceedances over 500 days. A reviewer proposes also evaluating the model with a scoring function. Which statement best describes the main advantage of a scoring function over a pure exceedance count?

A scoring function incorporates the magnitude of the loss relative to the VaR forecast, whereas an exceedance count only records whether a breach occurred. This lets analysts distinguish models with small breaches from those with severe ones and rank competing models on a common numerical basis.

  1. AIt uses the size of the loss relative to the VaR forecast, not just whether an exceedance occurredCorrect
  2. BIt removes the need for any historical loss data
  3. CIt guarantees that the model will pass the Basel traffic-light test
  4. DIt tests only whether exceedances are independent over time

Explanation

Exceedance counts treat a small breach and a huge breach identically. A scoring function assigns a numerical penalty that depends on the actual loss and the forecast, so it captures magnitude and allows ranking of models. It does not remove data needs, and it is not limited to testing independence.

Did you get it right without looking?

One question tells you little. A timed set on Beyond Exceedance-Based Backtesting of Value-at-Risk Models shows your real accuracy, how long you take and where you lose marks.

Practise Beyond Exceedance-Based Backtesting of Value-at-Risk ModelsFree diagnostic mock

More Beyond Exceedance-Based Backtesting of Value-at-Risk Models questions