Answer-first summary for fast verification
Answer: The risk-taking units of the bank will likely be allocated less capital than they should be.
C is correct. A model that produces too many exceptions may cause too little capital to be allocated to risk-taking units. **Explanation:** - **Option A is incorrect** because observing too many or too few exceptions is not related to the confidence level of the model. - **Option B is incorrect** because a model that produces too many exceptions is actually underestimating the market risk the bank faces, not overestimating it. - **Option C is correct** because when a VaR model produces more exceptions than expected, it means the model is underestimating risk. This leads to insufficient capital allocation to risk-taking units, as the calculated VaR (which determines capital requirements) is lower than it should be. - **Option D is incorrect** because while regulators may impose penalties for poorly designed models or deliberate underestimation of risk, they may not impose penalties if the exceedances are the result of bad luck or intraday trading. **Key Learning Points:** - VaR exceptions occur when actual losses exceed the VaR estimate - Too many exceptions indicate the model underestimates risk - This leads to inadequate capital allocation to risk-taking business units - Backtesting helps validate the accuracy of VaR models
Author: LeetQuiz .
Ultimate access to all questions.
No comments yet.
An analyst at a bank is asked to evaluate the efficacy of the VaR model that the bank used over the last year. While evaluating the model, the analyst finds that the bank experienced more VaR exceptions than were forecast by the bank's VaR model and examines both the reason this occurred and its potential impact on the bank. Which of the following is correct regarding the analyst's examination of the situation?
A
The confidence level of the backtest performed on the VaR model was set too low.
B
The model is most likely overestimating the market risk faced by the bank.
C
The risk-taking units of the bank will likely be allocated less capital than they should be.
D
The bank's regulator will impose a financial penalty on the bank.