Skip to content

FRM Part II · FRM Exam Part II · Illiquid Assets

A fund of funds estimates that an illiquid infrastructure fund's reported returns follow smoothing with α = 0.50. It reports a beta of 0.30 to global equities from reported returns, and its reported volatility is 6.0%. A colleague proposes unsmoothing, assuming true returns are serially uncorrelated and the market return is unsmoothed with contemporaneous correlation only. Which conclusion about the effect on risk estimates is most appropriate?

Unsmoothing raises volatility to about 10.4% and also raises contemporaneous beta. The smoothing factor is about 0.577, so reported 6.0% volatility is divided by it, and because smoothing delays market effects, the contemporaneous beta was understated.

  1. AVolatility roughly rises to about 10.4%, and measured beta based on contemporaneous returns would also tend to riseCorrect
  2. BVolatility is unchanged but beta rises because of a change in correlation
  3. CVolatility falls because unsmoothing removes noise, and beta falls
  4. DVolatility rises to 18.0% because the divisor is 1/3, and beta is unaffected

Explanation

Factor sqrt((1-α)/(1+α)) = sqrt(0.5/1.5) = 0.577, so true volatility = 6.0%/0.577 ≈ 10.4%. Smoothing spreads market moves over several periods, so contemporaneous beta is understated and rises after unsmoothing. Dividing by 1/3 is a misuse of the factor, and beta is not unaffected.

Did you get it right without looking?

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

Practise Illiquid AssetsFree diagnostic mock

More Illiquid Assets questions