Explanation:
The correct answer is A.
It would be quite difficult for a 10-day expected shortfall to be directly back-tested and also impossible to back-test stressed VaR or stressed ES.
VaR is a statistical measure used to estimate the maximum potential loss in the value of a portfolio or trading book over a specified time horizon (usually one day) at a certain confidence level. It is relatively straightforward to calculate and back-test because it provides a clear and quantifiable estimate of risk.
Expected Shortfall (ES), on the other hand, represents the average loss in the tail of the distribution beyond the VaR. It is often calculated over a longer time horizon (e.g., 10 days) and is more challenging to back-test directly because it involves considering the behavior of extreme events over a longer period.
Stressed VaR and stressed ES are even more complex to back-test because they require considering extreme market conditions and shocks, which are difficult to replicate accurately in historical data.
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Q.2999 The Fundamental Review of the Trading Book (FRTB) suggests that back-testing should be conducted using a VaR measure calculated over a one-day horizon and the most recent 12 months of data. What is the primary reason for this specific proposal?
A
This is due to the difficulty in directly backtesting a 10-day expected shortfall and impossible to back-test stressed VaR or stressed ES.
B
The events of a contractual default, acceptable remedies, and opportunities for a default to be cured, should be well defined in the FRTB. Therefore, termination rights should also be included in agreements.
C
The reasonability of the proposed limitations compared to the institution’s risks in case of performance failure by the service provider should be ascertained by the senior management and the Board of Directors in the institution.
D
None of the above.