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FRM Part II · FRM Exam Part II · Non-parametric Approaches

A risk manager is deciding whether to extend the historical simulation window from 250 days to 1,000 days. Which statement best describes the trade-off?

A longer window gives more tail observations and lowers sampling error, but it includes older data that may be irrelevant to current conditions and makes VaR slower to react. Shorter windows do the opposite, so the choice is a precision versus responsiveness trade-off.

  1. AA longer window reduces sampling error in the tail but makes VaR less responsive and may include outdated, irrelevant dataCorrect
  2. BA longer window raises sampling error but makes VaR respond faster to new volatility
  3. CA longer window removes the ghost effect entirely because older data are discounted
  4. DA longer window has no effect on VaR precision because the method is non-parametric

Explanation

More observations give more tail data and improve precision, but older observations may reflect different market regimes and dilute recent information, slowing response. The ghost effect, when large losses drop out of the window, still occurs with longer windows; only the timing changes.

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