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?
- The bank can ignore these backtesting results if it can show that Expected Shortfall was never breached during the year at all.
- 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.
- The bank must decrease its regulatory capital requirement, because a model that produces this many exceptions is evidently far too conservative.
- 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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