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FRM Part II · FRM Exam Part II · VaR and Risk Budgeting in Investment Management

A manager's portfolio has the same absolute VaR as its benchmark, but the portfolio holds substantially different securities and weights. Which statement about its relative VaR is most accurate?

Relative VaR can still be large. It is driven by the volatility of active returns, which depends on active weights and the correlation with the benchmark, so two portfolios with equal absolute VaR can differ greatly in tracking error and relative VaR.

  1. ARelative VaR must be zero because absolute VaRs are equal
  2. BRelative VaR can be large because it depends on active positions and correlation, not on the absolute VaR levels aloneCorrect
  3. CRelative VaR equals the absolute VaR because the benchmark risk is identical
  4. DRelative VaR is always lower than absolute VaR when a benchmark is used

Explanation

Relative VaR depends on the volatility of the active return, which reflects the active weights and the correlation between portfolio and benchmark. Equal standalone volatilities can coexist with low correlation and thus a high tracking error. The other options wrongly link relative VaR to absolute VaR levels.

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