A P&L-based GARCH model is relatively simple to implement as it uses historical P&L data, which is readily available. It serves as a useful benchmark because it provides a basic but challenging comparison for more complex internal VaR models. The simplicity and direct use of historical data make it a good baseline for evaluating the performance of more advanced models.

A is incorrect. P&L-based VaR is not suitable for active risk management and does not capture positional risk as it should.

C is incorrect. P&L-based models do not explicitly capture the dynamic nature of trading portfolios arising from changes in positions.

D is incorrect. GARCH models still rely on assumptions, such as the distribution of the innovations.

Things to Remember

• Benchmarking helps determine if a more complex model provides significant improvement over a simpler, more readily available alternative.
• The choice of loss function is crucial in benchmarking, as it reflects the specific concerns of the stakeholder (e.g., regulator, internal risk manager).