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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 a decay factor lambda of 0.98. Relative to equal weighting, what is the main effect on the VaR estimate when market volatility has just risen sharply?

VaR adapts faster to the new higher volatility. Age-weighting gives recent observations larger probability weights, so recent large losses move into the tail quickly and influence the quantile more than under equal weighting, where old and new data count the same.

  1. AVaR responds more quickly to the new, higher volatility because recent observations carry more weightCorrect
  2. BVaR responds more slowly because older observations are given extra weight
  3. CVaR is unchanged because the weights only affect the ordering of losses, not the quantile
  4. DVaR falls because the weights sum to less than one

Explanation

Under BRW weighting, recent observations get higher probability weights, so recent large losses enter the tail more heavily. VaR therefore adapts faster to a volatility increase. Option B reverses the weighting direction. Option C is wrong because weights change the cumulative probability used to locate the quantile.

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