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FRM Part I · FRM Exam Part I · Measures of Financial Risk

A risk analyst uses historical simulation with 500 daily P&L observations to estimate the 99% one-day VaR. Using the convention that VaR is the loss at the observation that leaves 1% of observations in the tail beyond it (i.e., the 5th worst loss is the VaR with 4 worse losses), which loss is the 99% VaR estimate?

The 5th worst loss is the 99% VaR. One percent of 500 observations equals five, and under the stated convention the fifth-worst outcome is the cutoff with four worse losses beyond it. The 4th and 6th worst losses correspond to different confidence levels.

  1. AThe worst loss
  2. BThe 4th worst loss
  3. CThe 5th worst lossCorrect
  4. DThe 6th worst loss

Explanation

1% of 500 observations is 5 observations. Under the stated convention, the 5th worst loss is the VaR estimate, with 4 losses exceeding it. The 4th worst would correspond to a 99.2% confidence level and the 6th to 98.8%.

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