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

Supervisors note that a bank's VaR model uses a one-day horizon and reports no exceptions in a year, with VaR far above typical daily losses. Which conclusion is most appropriate for the validation team?

Too few exceptions suggest the model may be overly conservative or mis-specified, so it should be investigated. Zero exceptions does not prove perfect calibration, because a correct 99% model should still show a few exceptions per year, and overstated VaR distorts capital and risk signals.

  1. AThe model is conservative and no further review is needed
  2. BThe model may be overly conservative or misstated, so excessive capital and poor risk signals warrant investigationCorrect
  3. CZero exceptions proves the model is perfectly calibrated
  4. DThe model should be switched to a 95% confidence level automatically

Explanation

Far fewer exceptions than expected (about 2.5 per 250 days at 99%) shows the model can be inaccurate in the conservative direction, which inflates capital and weakens risk signals. Zero exceptions is not proof of calibration, and the change of confidence level is not an automatic fix.

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