Skip to content

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

A risk manager uses a delta-normal approach to compute one-day 99% VaR for a portfolio that contains a large position in short-dated options. Which limitation of analytical VaR is most directly relevant to this portfolio?

The delta-normal method treats option positions as linear in the underlying risk factors. Because option payoffs are nonlinear, ignoring gamma can misstate VaR, particularly for large market moves. This is the key limitation for an options-heavy portfolio, unlike the other listed claims.

  1. AThe linear approximation poorly captures the nonlinear payoff of options, so VaR can be misstatedCorrect
  2. BThe approach cannot be applied if returns have a nonzero mean
  3. CThe approach requires full revaluation of every position under thousands of simulated scenarios
  4. DThe approach cannot produce a VaR figure for horizons longer than one day

Explanation

Delta-normal VaR approximates position values as linear in risk factors. Options have convexity (gamma), so large moves produce losses or gains that the linear approximation misses. Full revaluation is a feature of Monte Carlo or historical simulation, not delta-normal, so option 3 is wrong.

Did you get it right without looking?

One question tells you little. A timed set on Portfolio Risk: Analytical Methods shows your real accuracy, how long you take and where you lose marks.

Practise Portfolio Risk: Analytical MethodsFree diagnostic mock

More Portfolio Risk: Analytical Methods questions