Financial Risk Manager Part 2
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A financial analyst at Bank LKs needs to authenticate the reliability of the bank's Value at Risk (VaR) model using a backtesting methodology. The analyst plans to use two separate datasets containing returns data to compare the predicted losses with the actual losses to complete this verification process. Among the given options, which two sets of return data would be most appropriate for executing this backtesting?
A financial analyst at Bank LKs needs to authenticate the reliability of the bank's Value at Risk (VaR) model using a backtesting methodology. The analyst plans to use two separate datasets containing returns data to compare the predicted losses with the actual losses to complete this verification process. Among the given options, which two sets of return data would be most appropriate for executing this backtesting?
Explanation:
B is correct. Ideally, the analyst will use both the actual and hypothetical returns for backtesting since both yield informative comparisons. If the model passes backtesting with hypothetical but not actual returns, the problem in the model lies with intraday trading. If the model does not pass backtesting with hypothetical returns, the modelling methodology should be re-examined.