Skip to content

FRM Part II · FRM Exam Part II · VaR Mapping

A risk team maps a large equity portfolio to a single market index using each stock's beta. The portfolio is concentrated in a few stocks of one industry. Which statement best describes the limitation of this mapping for VaR?

Mapping to one index captures only systematic risk. For a concentrated, undiversified portfolio, specific risk stays large and is left out, so the mapped VaR can understate true total risk. The approximation works well only when diversification makes idiosyncratic risk negligible.

  1. AMapping to the index overstates total risk because it adds idiosyncratic risk twice
  2. BThe mapped VaR captures only systematic risk and may understate total risk because undiversified specific risk remains unmodelledCorrect
  3. CThe mapped VaR is exact whenever betas are estimated from at least 60 observations
  4. DMapping to an index makes VaR independent of the portfolio weights

Explanation

A single-index mapping captures only the market-factor component. In a concentrated portfolio, residual (specific) risk is not diversified away, so omitting it understates total risk. Large diversified portfolios make this error small, but here it is material. The other options misstate how mapping works.

Did you get it right without looking?

One question tells you little. A timed set on VaR Mapping shows your real accuracy, how long you take and where you lose marks.

Practise VaR MappingFree diagnostic mock

More VaR Mapping questions