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

A risk analyst replaces equal-weighted historical simulation with the age-weighted (BRW) approach using decay factor lambda = 0.98 on a 250-day window. Compared with equal weighting, what is the main effect on VaR estimates following a sudden rise in market volatility?

Age-weighted historical simulation makes VaR react faster to a volatility increase, because recent observations carry more probability weight than older ones. Equal weighting treats all days alike and so responds slowly. Weighting changes cumulative tail probability, and the method remains non-parametric.

  1. AVaR responds more quickly because recent observations receive higher weightsCorrect
  2. BVaR responds more slowly because older observations receive higher weights
  3. CVaR is unchanged because weights do not affect the ordering of losses
  4. DVaR becomes parametric and assumes normally distributed returns

Explanation

In BRW weighting, recent observations get higher probability weights, so a recent volatility spike enters the tail with larger weight and raises VaR faster. Equal weighting gives the same 1/n weight to old and new data, so it reacts slowly. Weights do change the cumulative probability at each loss, so option C is wrong.

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