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FRM Part I · FRM Exam Part I · Measuring and Monitoring Volatility

A firm sets its risk limits using only 250-day historical volatility. Markets then enter a sudden stress period. Compared with an implied volatility measure such as the VIX, the historical estimate will most likely:

Historical volatility from a long equally weighted window adjusts slowly, so it understates risk early in a stress episode. Implied volatility updates immediately because option prices incorporate new information and forward-looking expectations.

  1. ARise immediately by more than implied volatility because it uses more data
  2. BAdjust more slowly, understating the new risk in the early days of the stressCorrect
  3. CRemain exactly unchanged because it ignores recent returns
  4. DOverstate risk because it is forward-looking

Explanation

An equally weighted 250-day window gives each new large return only a small weight, so the estimate responds slowly. Implied volatility reflects option prices that update instantly with new information and expectations.

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