The FRTB proposes back-testing be done using a VaR measure calculated over a one-day horizon and the most recent 12 months of data. (This is because it is difficult to back-test a 10-day expected shortfall directly and not possible to back-test stressed VaR or stressed ES.)

Things to Remember

• Value-at-Risk (VaR) is a measure used to assess the potential loss in value of a risky asset or portfolio over a specific time horizon with a certain level of confidence.
• Expected Shortfall (ES) is a risk measure that quantifies the expected loss in the tail of the distribution beyond the VaR level.
• Back-testing is a process used to assess the accuracy of a VaR model by comparing the predicted VaR to the actual losses observed over a historical period.
• The Fundamental Review of the Trading Book (FRTB) aims to address shortcomings in the current regulatory framework for trading book capital requirements and improve risk management practices.
• Regulatory frameworks like FRTB are designed to ensure that banks maintain adequate capital reserves to cover potential losses from their trading activities.