Skip to content

FRM Part II · FRM Exam Part II · Validating Bank Holding Companies' Value-at-Risk Models for Market Risk

A supervisory review of several bank holding companies found that reported trading VaR was often much lower than the profit and loss variability seen at the firm level. A key reason a bank's VaR backtest could look favorable while the model is still weak is that:

Actual P&L includes intraday trading, fees, commissions and reserve changes that VaR does not model. These contaminate the comparison, so a backtest can look fine while the model is weak. Using hypothetical, clean P&L alongside actual P&L gives a more reliable validation.

  1. AHypothetical P&L is always larger than actual P&L
  2. BActual P&L includes intraday trading, fees and reserve changes that are not modeled in VaR, which can blur the comparisonCorrect
  3. CBacktests use a 95% confidence level by regulation
  4. DVaR models are always calibrated to the worst day in history

Explanation

Actual P&L contains items such as intraday trading revenue, fees, commissions and reserve adjustments that the VaR model does not capture, so comparing it with VaR can mask model flaws. Cleaner (hypothetical) P&L is preferred for testing the model itself. The other statements are false.

Did you get it right without looking?

One question tells you little. A timed set on Validating Bank Holding Companies' Value-at-Risk Models for Market Risk shows your real accuracy, how long you take and where you lose marks.

Practise Validating Bank Holding Companies' Value-at-Risk Models for Market RiskFree diagnostic mock

More Validating Bank Holding Companies' Value-at-Risk Models for Market Risk questions