medium · FRM Part 1 Valuation and Risk Models

A bank's risk model produces 11 exceptions over 250 days for a 99% VaR.

According to the Basel 'Traffic Light' system, what is the most likely regulatory consequence?

  1. The bank can ignore these backtesting results if it can show that Expected Shortfall was never breached during the year at all.
  2. The model enters the Yellow Zone, and the bank must prove that the exceptions were due to bad luck to avoid a capital penalty multiplier.
  3. The bank must decrease its regulatory capital requirement, because a model that produces this many exceptions is evidently far too conservative.
  4. The model enters the Red Zone, leading to a presumptive conclusion that the model is not valid and an increase in the multiplier to 4.0.

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