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

A risk analyst at a trading desk uses historical simulation with a 500-day window to compute 99% one-day VaR. Which of the following is a recognized advantage of this non-parametric approach compared with a delta-normal approach?

Historical simulation does not require a distributional assumption such as normality, because it uses actual observed returns. This lets it capture skewness and fat tails present in the sample, unlike delta-normal. It does not weight recent data more, nor react quickly to volatility shifts.

  1. AIt requires no assumption that portfolio returns follow a normal distributionCorrect
  2. BIt gives more weight to recent observations than to older ones
  3. CIt guarantees that VaR will rise immediately when volatility increases
  4. DIt produces precise tail estimates even with few observations

Explanation

Historical simulation uses the empirical distribution of returns, so it avoids distributional assumptions such as normality and handles fat tails and skewness present in the sample. Equal weighting of observations means it does not emphasize recent data and responds slowly to volatility changes. Tail estimates from few extreme observations are imprecise.

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