This appendix presents the framework for incorporating backtesting and profit and loss (P&L) attribution into the internal models approach to market risk capital requirements. It represents an elaboration of paragraph 183 of the internal models Accord text.
P&L attribution and backtesting are critical components of the revised internal models approach for capitalising trading activities. In order for a bank to obtain approval to use internal models to capitalise its trading exposures, it must meet several qualitative and quantitative criteria outlined in paragraphs 180 and 181. A key component of these requirements is that the bank demonstrates that its internal models, both at the firm-wide level and for individual trading desks, can model P&L behaviour with an appropriate degree of accuracy.
The essence of both P&L attribution and backtesting tests is the comparison of actual trading results with model-generated risk measures. If this comparison is c
…