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

A validation team varies the correlation assumption between two asset classes from 0.3 to 0.9 while holding all other inputs constant and records the change in portfolio VaR. What is the main purpose of this exercise?

The purpose is sensitivity analysis: showing how much VaR changes when an uncertain input such as correlation is altered while everything else is fixed. This highlights the assumptions that drive results and where estimation error matters most, rather than counting exceptions or setting capital multipliers.

  1. ATo measure the number of backtesting exceptions
  2. BTo assess how sensitive VaR is to an uncertain model input and identify assumptions that drive resultsCorrect
  3. CTo replace the VaR model with a stress loss measure
  4. DTo calibrate the multiplier used in capital requirements

Explanation

Sensitivity analysis changes one assumption at a time to see how much the output moves, revealing which inputs matter most and where estimation error is most dangerous. It does not count exceptions, replace VaR, or set the regulatory multiplier.

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