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Answer: Traditional VaR measures can be tested to see how well they would have worked in the past, but stressed VaR cannot be effectively back-tested.
## Explanation **A is correct** because stressed VaR focuses on extreme outcomes that are not expected to occur with any particular frequency, making effective back-testing impossible. Traditional VaR can be back-tested against historical data to validate its performance. **B is incorrect** because VaR-based approaches for market risk typically use short time horizons (often one day), while stress testing examines much longer periods (commonly 3 months to 2 years). **C is incorrect** because backward-looking VaR analysis considers numerous scenarios from historical data (both favorable and unfavorable), whereas stress testing focuses on a limited number of specifically adverse scenarios. **D is incorrect** because stress testing does not provide a complete probability distribution of losses. It typically uses a small set of predefined scenarios (such as baseline, adverse, and severely adverse in CCAR tests), unlike VaR and ES methods that do model probability distributions.
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The newly hired CRO of a fast-growing multinational bank is reviewing the bank's stress testing process and VaR-based economic capital framework. The CRO wants to ensure that the bank's framework and methodologies reflect best practices put forward by the Basel Committee. In conducting this review, which of the following statements is most appropriate for the CRO to make?
A
Traditional VaR measures can be tested to see how well they would have worked in the past, but stressed VaR cannot be effectively back-tested.
B
Typically, a VaR-based calculation for market risk capital estimates losses over a multi-year period, while an enterprise-wide stress test focuses on losses over a shorter time period.
C
VaR-based economic capital methods and enterprise-wide stress tests typically look at a similar number of loss scenarios.
D
Enterprise-wide stress tests typically require modeling the full probability distribution of losses, while VaR-based economic capital estimates do not.