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

A validator runs a sensitivity analysis on a bank's VaR model by changing the lookback window from 250 to 500 days while holding all else constant, and the 99% one-day VaR rises from USD 8.0 million to USD 10.4 million. Which interpretation is most appropriate?

The 30% jump in VaR from changing only the lookback window shows the model is materially sensitive to that parameter. Validators should require the window choice to be justified and the sensitivity documented, rather than assuming either a coding error or conservatism.

  1. AThe model is validated because VaR increased, which is conservative
  2. BThe model is highly sensitive to the window choice, so the window length should be justified and its impact documentedCorrect
  3. CThe change shows the model has a coding error that must be fixed before any use
  4. DThe result is irrelevant because sensitivity tests apply only to option positions

Explanation

A 30% increase (10.4/8.0 = 1.30) from one parameter change shows material dependence on the window. Validators should require justification of the choice and documentation of the sensitivity. It does not by itself prove a coding error, and sensitivity testing applies to any model input.

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