FRM Part I · FRM Exam Part I · Measuring and Monitoring Volatility
A risk analyst uses an EWMA model with decay factor lambda = 0.94. The previous day's volatility estimate was 1.00% per day, and today's observed return was 2.00%. What is the updated daily volatility estimate (to two decimals)?
The EWMA variance is 0.94 times 1.00 plus 0.06 times 4.00, which equals 1.18 in squared percent. Taking the square root gives a daily volatility of about 1.09%. The figure 1.18 is only the variance.
- A1.18%Correct
- B1.00%
- C1.39%
- D1.72%
Explanation
EWMA variance = 0.94 x (1.00)^2 + 0.06 x (2.00)^2 = 0.94 + 0.24 = 1.18 (in %^2). The volatility is sqrt(1.18) = 1.086%, which rounds to 1.09%. Checking the options, none equals 1.09%, so recompute: the answer listed, 1.18%, is the variance and not the volatility, so the item must be corrected.
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