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FRM Part II · FRM Exam Part II · Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

A portfolio manager holds an emerging market equity fund. Using a stylized estimate, a one-standard-deviation rise in a geopolitical risk index lowers the one-month-ahead equity return distribution's lower tail (5th percentile) from -8% to -11%, while the median return is unchanged. What is the best interpretation for risk management?

The shock mainly increases downside tail risk. The median return is unchanged while the 5th percentile worsens by three percentage points, from -8% to -11%, so losses in bad states grow even though the average outcome looks stable. Risk limits should reflect the fatter left tail.

  1. AThe geopolitical shock mainly raises downside tail risk rather than shifting the average returnCorrect
  2. BThe shock reduces volatility because the median is unchanged
  3. CThe shock affects only the upper tail of returns
  4. DThe shock is diversifiable and should not alter risk limits

Explanation

An unchanged median with a worse 5th percentile (3 percentage points lower) shows the effect operates through the left tail, consistent with a growth-at-risk or tail-risk framing. Volatility does not fall, and the upper tail is not the one affected.

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