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FRM Part I · FRM Exam Part I · The Governance of Risk Management

Before the 2007-2009 crisis, several firms relied heavily on a single VaR figure to report risk to the board. Which lesson about board-level risk reporting is most appropriate?

Boards should see VaR alongside stress tests, scenario analysis and concentration data. VaR ignores losses beyond its confidence level and depends on past data, so supplementary measures make tail risks and model limitations visible, supporting more informed oversight.

  1. AVaR should be removed from all board reports because it cannot be computed reliably
  2. BThe board should receive only qualitative narratives since numbers can mislead
  3. CReports should be limited to realized losses, as forecasts are unreliable
  4. DBoard reports should combine VaR with stress tests, scenario analysis and concentration information so tail risks and model limits are visibleCorrect

Explanation

VaR says nothing about losses beyond its threshold and relies on historical data, so it hid tail and concentration risk. Complementing it with stress and scenario analysis addresses this; abandoning quantitative measures or using only realized losses discards useful forward-looking information.

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