Skip to content

FRM Part II · FRM Exam Part II · Risk, Regulation and Organizational Structure

A regulator wants to measure the systemic importance of a hedge fund by how much the broader financial system's expected loss rises when the fund is in distress, relative to normal conditions. A risk analyst observes that the fund's standalone VaR is small, yet its distress coincides with many large losses at banks. Which conclusion is most consistent with systemic risk measures such as CoVaR?

The fund can still be systemically important. CoVaR-type measures capture how the system's tail losses rise conditional on the fund's distress, reflecting tail dependence and interconnectedness, which standalone VaR ignores. Low own VaR therefore does not imply a low systemic contribution.

  1. AThe fund is not systemically important because standalone VaR is low
  2. BThe fund's systemic contribution is captured by conditional tail dependence, so it can be systemically important despite low standalone VaRCorrect
  3. CCoVaR equals the fund's standalone VaR by construction, so the two always rank institutions identically
  4. DSystemic importance depends only on the fund's total assets, not on co-movement with the system

Explanation

CoVaR measures system VaR conditional on an institution being in distress; the difference from the unconditional value gives its marginal contribution. It captures tail co-movement and interconnectedness that standalone VaR ignores. Hence low own VaR does not imply low systemic importance, and the two measures need not rank institutions alike.

Did you get it right without looking?

One question tells you little. A timed set on Risk, Regulation and Organizational Structure shows your real accuracy, how long you take and where you lose marks.

Practise Risk, Regulation and Organizational StructureFree diagnostic mock

More Risk, Regulation and Organizational Structure questions