Explanation:
The null hypothesis () in VaR backtesting is that the VaR model is accurate. At a 99% confidence level, over 224 days, the expected number of exceptions is $224 \times 1% = 2.24$. Since 12 exceptions were observed, the model is highly likely to be inaccurate (it underestimates risk). By accepting the model as accurate despite strong evidence to the contrary, one fails to reject a false null hypothesis. Failing to reject a false null hypothesis is the definition of a Type II error.
Ultimate access to all questions.
Q.11 A model gives an annual VaR value of $9.5 million for a portfolio at a 99% confidence interval. A one-year backtest conducted at the 95% confidence level reveals that losses exceeded $9.5 million on 12 occasions. The model is accepted as accurate. Assuming 224 days in a year, which of these statements is most likely true?
A
A Type I error has occurred.
B
A Type II error has occurred.
C
Both Type I and Type II errors have occurred.
D
The model has been accepted correctly.
No comments yet.