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FRM Part II · FRM Exam Part II · Non-parametric Approaches

A portfolio manager notes that volatility was very high in the oldest part of a 4-year historical window but is low now. Compared with the current risk, basic historical simulation VaR will most likely be:

VaR will likely be overstated. Basic historical simulation gives equal weight to every observation in the window, so old high-volatility days keep influencing the tail quantile even though current volatility is low. Age-weighting or volatility-weighting corrects this.

  1. AUnderstated, because older observations are ignored
  2. BAccurate, because all observations carry equal weight
  3. COverstated, because old high-volatility observations still carry the same weight as recent onesCorrect
  4. DZero, because low volatility removes tail observations

Explanation

Basic historical simulation weights all observations equally, so stale high-volatility days remain in the tail and inflate VaR relative to current conditions. Age-weighted or volatility-weighted variants address this.

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