medium · Frm Part 2 Market Risk
A risk manager is backtesting a 99% daily Value at Risk (VaR) model over a trailing 250-day window. The model records 3 exceptions.
If the manager decides to increase the significance level of the statistical test to reduce the probability of a false alarm (Type 1 error), what is the most likely consequence for the model's validation process?
- The statistical power of the test will increase significantly.
- The probability of a Type 2 error (accepting a flawed model) will increase.
- The expected number of exceptions (Tp) will shift from 2.5 to a higher value.
- The test becomes more likely to reject a model that is actually understating risk.
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