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FRM Part II · FRM Exam Part II · Portfolio Risk: Analytical Methods

A portfolio manager wants to reduce portfolio VaR as efficiently as possible by trimming one position. According to standard VaR decomposition practice, which position should be reduced first?

Reduce the position with the highest marginal VaR per dollar, because that gives the largest fall in portfolio VaR for each dollar removed. Notional size and standalone VaR ignore correlations with the rest of the portfolio, so they can mislead.

  1. AThe position with the highest marginal VaR per dollarCorrect
  2. BThe position with the largest notional
  3. CThe position with the highest standalone VaR
  4. DThe position with the lowest expected return

Explanation

Marginal VaR measures the change in portfolio VaR per unit of position, so trimming the highest marginal VaR reduces risk most per dollar. Notional and standalone VaR ignore correlation effects. Expected return is unrelated to risk reduction efficiency.

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