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

A pension fund manager reports that a portfolio's 95% one-month absolute VaR is USD 12 million, while its 95% one-month relative VaR against the benchmark is USD 3 million. Which statement best interprets the relative VaR figure?

Relative VaR measures the potential shortfall of the portfolio against its benchmark. A USD 3 million 95% relative VaR means a 5% chance of underperforming the benchmark by more than USD 3 million over the month, not an absolute loss.

  1. AThere is a 5% chance the portfolio loses more than USD 3 million in absolute terms over the month
  2. BThere is a 5% chance the portfolio underperforms its benchmark by more than USD 3 million over the monthCorrect
  3. CThere is a 5% chance the benchmark loses more than USD 3 million over the month
  4. DThere is a 95% chance the portfolio outperforms its benchmark by USD 3 million

Explanation

Relative VaR is the VaR of the active return, portfolio minus benchmark. At 95% it is the shortfall versus the benchmark that is exceeded with 5% probability. The absolute VaR of USD 12 million is the figure describing absolute losses, so the first option confuses the two measures.

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