FRM Part II · FRM Exam Part II · VaR Mapping
A risk manager maps a concentrated portfolio of five technology stocks to a broad market index using betas only. Which limitation is most important?
In a concentrated portfolio, idiosyncratic risk is not diversified away. Mapping only to the market index captures systematic risk, so it understates total VaR unless specific risk is added separately.
- ASpecific risk is large in a concentrated portfolio, so index-only mapping will understate VaRCorrect
- BBeta mapping overstates VaR because it counts diversification twice
- CBeta mapping cannot be applied to equities, only to bonds
- DBeta mapping requires full revaluation of each stock
Explanation
Mapping to the index captures only systematic risk. With few stocks, idiosyncratic risk is not diversified away, so ignoring it understates total VaR. Betas are easily applied to equities and the method is a linear, not full-revaluation, approach.
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