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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. She wants the exact change in portfolio VaR from adding the whole position, rather than a linear approximation. Which measure should she use?

She should use incremental VaR, the difference between portfolio VaR with and without the new position. It captures the full effect of a large trade, whereas marginal VaR is only a linear approximation for small changes and standalone VaR ignores diversification.

  1. AIncremental VaR, computed as VaR with the position minus VaR without itCorrect
  2. BMarginal VaR, multiplied by the position size
  3. CComponent VaR of the existing positions
  4. DStandalone VaR of the new position

Explanation

Incremental VaR is the full revaluation difference between portfolio VaR with and without the position, so it captures nonlinearity. Marginal VaR times size is only a first-order approximation, valid for small changes. Standalone VaR ignores diversification.

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