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Hi,

Practice Question number 3 in the GARP Market Risk reading goes like this:

You are backtesting a bank's VaR model. Currently, the bank calculates a 1-day VaR at the 99% confidence level, and you are recommending that it switch to a 95% confidence level. Which of the following statements concerning this switch is correct?

A. The 95% VaR model is less likely to be rejected using backtesting than the 99% VaR model.

B. When validating with backtesting at the 90% confidence level, there is smaller probability of incorrectly rejecting a 95% VaR model when it is valid than a 99% VaR model.

C. The decision to accept or reject a VaR model based on backtesting results is more reliable with a 95% confidence level VaR model than with a 99% confidence level VaR model

D. When backtesting using a 90% confidence level, there is a smaller probability of committing a type 1 error when backtesting a 95% VaR model than with a 99% VaR model.

The official answer is C.

I agree that C is correct. But aren't B and D also correct?

In fact isn't B and D together the same as C, i.e. the decision is more reliable, since the probability of making an error (type 1 or 2) is smaller.

Is the question just weird, or do I miss something here?

Practice Question number 3 in the GARP Market Risk reading goes like this:

You are backtesting a bank's VaR model. Currently, the bank calculates a 1-day VaR at the 99% confidence level, and you are recommending that it switch to a 95% confidence level. Which of the following statements concerning this switch is correct?

A. The 95% VaR model is less likely to be rejected using backtesting than the 99% VaR model.

B. When validating with backtesting at the 90% confidence level, there is smaller probability of incorrectly rejecting a 95% VaR model when it is valid than a 99% VaR model.

C. The decision to accept or reject a VaR model based on backtesting results is more reliable with a 95% confidence level VaR model than with a 99% confidence level VaR model

D. When backtesting using a 90% confidence level, there is a smaller probability of committing a type 1 error when backtesting a 95% VaR model than with a 99% VaR model.

The official answer is C.

I agree that C is correct. But aren't B and D also correct?

In fact isn't B and D together the same as C, i.e. the decision is more reliable, since the probability of making an error (type 1 or 2) is smaller.

Is the question just weird, or do I miss something here?

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