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

A risk analyst replaces equal weighting in a historical simulation with the age-weighted (BRW) approach using a decay factor lambda of 0.98. Compared with equally weighted historical simulation, which outcome is most likely immediately after a sharp rise in market volatility?

The VaR estimate responds faster. Age-weighted historical simulation assigns geometrically declining weights to older data, so recent large losses have more influence on the percentile than under equal weighting, making VaR more responsive to a volatility increase.

  1. AThe VaR estimate responds faster because recent large losses carry more weightCorrect
  2. BThe VaR estimate responds more slowly because older observations carry more weight
  3. CThe VaR estimate is unchanged because the same observations are used
  4. DThe VaR estimate falls because weights sum to less than one

Explanation

BRW gives the most recent observations the highest weights, declining geometrically with age. After a volatility spike, recent large losses therefore push the VaR up faster than under equal weights. The slower-response option reverses the weighting logic, and the weights are normalized to sum to one.

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