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Version date: 14 January 2016 - onwards

Appendix B Supervisory framework for the use of backtesting and profit and loss attribution in conjunction with the internal models approach to market risk capital requirements

 I. Introduction

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

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