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FRM Part II · FRM Exam Part II · Parametric Approaches (II): Extreme Value

A risk manager uses EVT to estimate 99.9% VaR for a trading desk but has only 500 daily observations. Which is the most important practical limitation of this approach?

The main limitation is data scarcity: with only 500 observations very few fall in the tail, so the fitted extreme value parameters are unreliable. EVT is intended for high confidence levels, does not assume normality, and can also produce expected shortfall.

  1. AWith so few data points, very few observations fall in the tail, making parameter estimates unreliableCorrect
  2. BEVT cannot be used for any confidence level above 95%
  3. CEVT requires that losses follow a normal distribution
  4. DEVT gives VaR but never expected shortfall

Explanation

At a 99.9% level, 500 observations imply fewer than one expected exceedance, so threshold exceedances are few and parameters are unstable. EVT is designed for high confidence levels, does not require normality, and can also give expected shortfall.

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