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Answer: Overnight examination by the junior analyst increased the desk's exposure to model risk due to the potential for incorrect calibration and programming errors.
The correct conclusion for the replacement of the existing VaR model with the new one is C: "Overnight examination by the junior analyst increased the desk's exposure to model risk due to the potential for incorrect calibration and programming errors." This is because the new model was implemented quickly without the standard evaluation process involving a senior member of the team and an extended testing period. The lack of exceedances in the new model after 6 weeks does not necessarily indicate that it is unbiased; rather, it could be a sign that the model is underestimating the risk due to potential flaws in its calibration or programming. The situation is reminiscent of the JP Morgan London Whale case in 2012, where a hastily introduced VaR model led to significant losses due to inadequate testing and potential errors. The insufficient review and testing of the new model have indeed increased the desk's exposure to model risk.
Author: LeetQuiz Editorial Team
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To better understand the implications of implementing a new Value at Risk (VaR) model to replace an existing one, consider the following statement. Which one correctly encapsulates the effects observed after the replacement?
A
Delta-normal VaR is more appropriate than historical simulation VaR for assets with non-linear payoffs.
B
Changing the look-back period and weighting scheme from 3 years, equally weighted, to 4 years, exponentially weighted, will understate the risk in the portfolio.
C
Overnight examination by the junior analyst increased the desk's exposure to model risk due to the potential for incorrect calibration and programming errors.
D
A 99% VaR model that generates no exceedances in 6 weeks is necessarily conservative.
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