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FRM Part II · FRM Exam Part II · VaR Mapping

A bank must choose a VaR method for a large book of options with significant gamma exposure and wants accuracy for large market moves. Which approach is most appropriate?

Full revaluation under simulated scenarios is most appropriate because it reprices options exactly and captures gamma and other nonlinearity for large moves. Delta-normal is only a local linear approximation, and cash-flow mapping addresses fixed income, not option payoffs.

  1. ADelta-normal mapping with a longer holding period
  2. BFull revaluation of the options using simulated risk factor scenariosCorrect
  3. CMapping each option to a zero-coupon bond
  4. DMapping to the cash-flow vertices using present value weights only

Explanation

Full revaluation reprices each option under each scenario, so it captures convexity and large nonlinear moves. Delta-normal is a local linear approximation and is poor for large moves with high gamma. Mapping to bonds or cash-flow vertices applies to fixed income cash flows, not option nonlinearity.

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