4
$\begingroup$

Regulators want to backtesting VaR estimates based on both Risk theoretical PnL and Actual PnL. My question is how can Backtesting of VaR be done with Actual PnL? Typically, financial instruments are classified as Amortised cost basis, FVTOCI and FVTPL, so for first 2 groups Bank would not or unlikely sell the instrument, so actual PnL data will not be available.

Could you please provide some insight how Backtesting with Actual PnL is done in practice?

$\endgroup$

1 Answer 1

1
$\begingroup$

I don't know about all regulators, but as far as I know, they prefer to backtest vakue at Risk "VaR" against "Hypothetical/Clean P&L" (HPL), rather than "Actual/Dirty P&L" (APL).

HPL is calculated by revaluing positions held at the end of prior day, using market data actually observed from the current day, to measure portfolio value changes that wwould have occurred if the positions didn't change, using static positions, buy-and-hold, not taking account the actual trading activity, cancelled, amended, or modified trades. Mark to market everything. The P&L is the change in mark to market.

APL is HPL plus the effect of the trading activity.

$\endgroup$
1
  • 2
    $\begingroup$ According to BCBS, MAR32.4 "Backtesting requirements compare the value-at-risk (VaR) measure calibrated to a one-day holding period against each of the actual P&L (APL) and hypothetical P&L (HPL) over the prior 12 months. Specific requirements to be applied at the bank-wide level and trading desk level are set out below." $\endgroup$
    – NN2
    Dec 16, 2023 at 7:07

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service and acknowledge you have read our privacy policy.

Not the answer you're looking for? Browse other questions tagged or ask your own question.