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FRM Part II · FRM Exam Part II · VaR Mapping

A risk manager uses a single-index (beta) mapping to estimate the VaR of a diversified equity portfolio against a broad market index. Which statement best describes what the resulting VaR captures?

Beta mapping represents each stock by its beta-weighted exposure to a market index, so the VaR reflects only systematic risk. Stock-specific risk is left out, which is reasonable for diversified portfolios but understates total risk for concentrated ones.

  1. AOnly the systematic risk from market index exposure, so it understates total risk when the portfolio holds concentrated positionsCorrect
  2. BBoth systematic and stock-specific risk, because each stock is mapped to its own risk factor
  3. COnly the specific risk of each stock, because the index risk is diversified away
  4. DTotal risk including correlation between specific returns, because betas are estimated from covariances

Explanation

Beta mapping replaces each stock with its beta-weighted exposure to the index. This captures only market (systematic) risk. Specific risk is ignored, which is acceptable for well-diversified portfolios but understates VaR for concentrated ones.

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