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FRM Part II · FRM Exam Part II · Backtesting VaR

Under the Basel traffic light approach to backtesting 99% one-day VaR over the most recent 250 trading days, a bank records 6 exceptions. In which zone does the bank fall, and what is the consequence for the regulatory multiplier?

The bank is in the yellow zone, because 5 to 9 exceptions out of 250 days fall in that band. The supervisory response is a higher multiplier than the base level of 3, while automatic model rejection is reserved for the red zone of 10 or more exceptions.

  1. AGreen zone; multiplier stays at the base level of 3
  2. BYellow zone; multiplier is increased above 3 as a supervisory add-onCorrect
  3. CYellow zone; the model is automatically rejected
  4. DRed zone; multiplier is increased to 4

Explanation

Green zone covers 0-4 exceptions, yellow covers 5-9, and red is 10 or more. Six exceptions places the bank in the yellow zone, where the multiplier add-on rises with the number of exceptions (6 exceptions gives 3.50 in the Basel table). Automatic rejection applies only in the red zone.

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