Skip to content

FRM Part II · FRM Exam Part II · VaR Mapping

A bank maps a USD 20 million equity portfolio holding 40 different stocks to a single market index using each stock's beta, instead of modeling each stock separately. Which risk is most likely to be understated by this approach?

Idiosyncratic risk is most likely understated. Mapping stocks to an index through beta captures only systematic exposure; the residual stock-specific risk is omitted. VaR will therefore be lower than true total risk unless specific risk is modeled separately or the portfolio is highly diversified.

  1. ASystematic market risk
  2. BIdiosyncratic (specific) risk of the individual stocksCorrect
  3. CInterest rate risk of the risk-free asset
  4. DExposure to the index's volatility

Explanation

Mapping to an index captures only the systematic component through beta. The residual, stock-specific risk is dropped, so measured VaR understates total risk unless the portfolio is well diversified or specific risk is added separately.

Did you get it right without looking?

One question tells you little. A timed set on VaR Mapping shows your real accuracy, how long you take and where you lose marks.

Practise VaR MappingFree diagnostic mock

More VaR Mapping questions