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FRM Part II · FRM Exam Part II · VaR Mapping

A risk manager at a bank must compute VaR for a portfolio holding thousands of bonds, equities and derivatives. Instead of modelling each position individually, she replaces each position with exposures to a small set of standard risk factors. What is the primary purpose of this VaR mapping step?

The main purpose of VaR mapping is to reduce dimensionality: positions are expressed as exposures to a small set of primitive risk factors, so only a manageable covariance matrix is needed. It simplifies measurement but still requires volatility and correlation inputs for those factors.

  1. ATo eliminate the need for any estimate of volatility and correlation
  2. BTo reduce the dimensionality of the risk problem by expressing positions in terms of a manageable set of risk factorsCorrect
  3. CTo guarantee that the resulting VaR is always higher than the true VaR
  4. DTo convert the portfolio's expected return into a risk-free return

Explanation

Mapping replaces many instruments with exposures to a limited set of primitive risk factors, so the covariance matrix needed is of manageable size. It does not remove the need for volatility and correlation inputs; it makes estimating them feasible. It does not bias VaR upward by design.

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