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FRM Part II · FRM Exam Part II · Beyond Exceedance-Based Backtesting of Value-at-Risk Models

Over 500 days, a 99% VaR model produces exactly 5 exceedances, matching expectations. However, all 5 occurred within one 8-day period during a market crisis. Which statement best describes what a simple unconditional coverage count fails to capture?

A simple exceedance count misses clustering. Five exceedances in an eight-day window match the expected total but show dependence, meaning the model reacts too slowly to volatility changes. Independence or conditional coverage tests are needed to detect this weakness.

  1. AClustering of exceedances, which indicates the model is slow to adapt to volatility changesCorrect
  2. BThe total number of exceedances over the sample
  3. CThe confidence level used for VaR
  4. DThe sign of the portfolio returns on non-exceedance days

Explanation

The unconditional count matches the expected 5, so it passes. But exceedances bunched together violate independence, signalling that VaR does not respond to rising volatility. Conditional coverage or independence tests are needed to detect this.

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