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FRM Part II · FRM Exam Part II · Portfolio Risk: Analytical Methods

A risk manager is considering adding a new position to a portfolio and wants to measure the exact change in portfolio VaR if the full position is added. Which measure is most appropriate, and how does it relate to component VaR for a large position?

Incremental VaR is the right measure. It is the difference between portfolio VaR with and without the new position, so it captures the exact change. Marginal and component VaR are only linear approximations that hold for small trades and diverge for large ones.

  1. AIncremental VaR; it is the full difference in VaR with and without the position and differs from the linear component VaR approximation for large tradesCorrect
  2. BComponent VaR; it exactly equals the change in VaR for any trade size
  3. CMarginal VaR; it is exact for any trade size because VaR is linear in positions
  4. DStand-alone VaR; it captures diversification so equals the VaR change

Explanation

Incremental VaR is VaR(with) minus VaR(without) and is the exact change. Marginal and component VaR are first-order (linear) approximations that are accurate only for small changes. Stand-alone VaR ignores diversification with the existing portfolio.

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