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FRM Part II · FRM Exam Part II · Backtesting VaR

Under the Basel traffic light approach to backtesting a 99% one-day VaR model over the most recent 250 trading days, a bank records 7 exceptions. In which zone does the model fall, and what is the associated treatment of the capital multiplier?

Seven exceptions in 250 days places the model in the yellow zone (5-9 exceptions). The supervisor adds an increment to the base multiplier of 3.0, which grows with the number of exceptions. The automatic maximum multiplier of 4.0 applies only to the red zone, 10 or more exceptions.

  1. AGreen zone; the multiplier stays at the minimum of 3.0
  2. BYellow zone; the supervisor adds an increment to the multiplier above 3.0Correct
  3. CYellow zone; the multiplier is automatically set at 4.0
  4. DRed zone; the model is automatically rejected and the multiplier is set at 4.0

Explanation

The green zone covers 0-4 exceptions, the yellow zone 5-9 and the red zone 10 or more. Seven exceptions is yellow, where the multiplier is increased by an add-on that rises with the number of exceptions (for 7 it is 0.65). The automatic 4.0 multiplier applies only in the red zone, so the other yellow-zone option is wrong.

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