Skip to content

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

A validator finds that a bank's internal VaR is consistently 30% lower than a benchmark model's VaR for the same equity portfolio, although both models pass backtesting with zero exceptions over 250 days. What is the most appropriate conclusion?

The persistent difference should be investigated. Differences in assumptions, such as volatility estimation or data window, may explain it, and zero exceptions over 250 days at 99% is fewer than the roughly 2.5 expected, which can indicate over-conservatism. Neither model should be accepted or dismissed automatically.

  1. AThe internal model is validated because it has no exceptions
  2. BThe benchmark is wrong because it is higher
  3. CThe persistent gap should be investigated, since the internal model may be overly conservative or the benchmark may differ in assumptions, and zero exceptions can itself signal over-conservatismCorrect
  4. DBacktesting results should be ignored in favor of the benchmark

Explanation

Zero exceptions in 250 days at 99% (expected about 2.5) suggests the internal VaR may be too high, not too low, while the benchmark is even higher; the difference in assumptions (volatility estimation, window, distribution) must be understood. Neither model should be accepted or rejected automatically, so the investigation option is correct.

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