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

Supervisory review of several large bank holding companies found that reported trading VaR was often well above the realized daily trading losses, with very few exceptions. Which interpretation is most consistent with the reading's findings?

Persistently few exceptions imply the VaR models were conservative and overstated risk, for instance through conservative inputs or aggregation. Too few exceptions is a sign of model inaccuracy, not superior performance, and it reduces the measure's usefulness for risk management and capital.

  1. AThe models were likely conservative or overstated, possibly because of conservatism in inputs or aggregation, which reduces their usefulness as an accurate risk measureCorrect
  2. BThe models were necessarily accurate because fewer exceptions than expected always indicate superior performance
  3. CThe banks were underreporting risk to lower their capital requirements
  4. DThe banks' portfolios contained no market risk factors

Explanation

Far fewer exceptions than the expected count suggests VaR is overstated, for example through conservative assumptions or summing across risk types without diversification. Too few exceptions is itself a model flaw, not proof of accuracy, and it implies overstatement rather than underreporting.

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