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Answer: The VaR model is understating risk.
## Explanation For a 95% VaR model over 252 trading days, the expected number of exceptions is: - Expected exceptions = 252 × (1 - 0.95) = 252 × 0.05 = 12.6 **Analysis:** - **Observed exceptions:** 19 - **Expected exceptions:** 12.6 - **Difference:** 19 - 12.6 = 6.4 exceptions above expected **Interpretation:** - When observed exceptions exceed expected exceptions, it indicates the VaR model is **underestimating risk** - More exceptions than expected mean the actual losses are exceeding the VaR estimate more frequently than the confidence level suggests - This suggests the model is not capturing the true risk level and is **understating risk** **Regulatory implications:** - Under Basel framework, excessive exceptions would move the bank into higher penalty zones - This would require the bank to apply a higher multiplication factor to its capital calculation Therefore, the correct answer is that the VaR model is **understating risk**.
Author: LeetQuiz .
Q-30. A bank conducted a backtest of its 95% daily value at risk (VaR) and observed 19 exceptions — i.e., the number of days where the daily P&L loss exceeded the VaR — over the last year.
A
The VaR model is correctly calibrated.
B
The VaR model is understating risk.
C
The VaR model is overstating risk.
D
The backtest results are inconclusive.
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