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FRM Part I · FRM Exam Part I · Measuring and Monitoring Volatility

Which feature is a recognized weakness of equally weighted moving average volatility estimates compared with exponentially weighted estimates?

Equally weighted estimates give every observation in the window the same weight, so a large shock affects the estimate fully until it drops out, causing an abrupt fall (the ghost effect). Exponential weighting avoids this by decaying old observations gradually.

  1. AVolatility estimates jump when a large shock leaves the window, creating ghost effectsCorrect
  2. BIt cannot be computed without assuming normally distributed returns
  3. CIt requires estimating a decay parameter by maximum likelihood
  4. DIt gives the most weight to the most recent observation

Explanation

Equal weights mean a large past shock keeps full influence until it exits the window, when the estimate drops abruptly (the ghost effect). The method needs no distributional assumption or decay parameter, and it does not overweight recent data.

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