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

During validation, a team finds that a VaR model uses a stale volatility surface for FX options, updated only monthly, while spot FX is updated daily. What is the best recommendation?

The team should recommend updating volatility inputs at a frequency consistent with daily revaluation and including vega risk factors. Stale monthly volatility data ignores a key risk driver of options, and changing confidence level or excluding options does not correct it.

  1. AAccept the practice because spot risk dominates option risk
  2. BIncrease the confidence level to compensate
  3. CIncrease update frequency of the volatility inputs and include vega risk factors consistent with daily revaluationCorrect
  4. DRemove the options from the VaR scope and report them separately without capital

Explanation

Stale volatility inputs ignore vega risk and misprice options in daily revaluation, so inputs must be refreshed with consistency and vega factors captured. Changing the confidence level or excluding positions does not fix input quality.

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