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FRM Part II · FRM Exam Part II · Estimating Market Risk Measures: An Introduction and Overview

A risk manager notes that an exponential spectral risk measure becomes much larger when the risk-aversion coefficient is increased. What is the best interpretation?

Increasing the risk-aversion coefficient moves weight onto the worst losses, so the spectral measure rises because extreme outcomes dominate the weighted average. It does not shift weight to good outcomes or equalize the weights; the opposite happens as aversion falls toward risk neutrality.

  1. AThe weights shift toward the worst outcomes, so the measure reflects greater aversion to extreme lossesCorrect
  2. BThe weights shift toward the best outcomes, so the measure falls toward the minimum loss
  3. CThe weights become equal across all quantiles, so the measure converges to the expected loss
  4. DThe confidence level of the measure has been reduced, so fewer tail losses are included

Explanation

In the exponential spectral form, a larger risk-aversion coefficient concentrates weight on the largest losses, raising the measure. Low aversion pushes the weights toward equal and the measure toward expected loss. Higher aversion does not reduce the confidence level; it changes the weighting of tail outcomes.

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