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FRM Part II · FRM Exam Part II · Non-parametric Approaches

Which statement about weighted historical simulation (age-weighted, BRW) is most accurate?

Age-weighted historical simulation reduces ghost effects. Old extreme losses carry diminishing weight, so their eventual exit from the window causes a smaller jump in VaR than under equal weighting. It remains non-parametric, still needs a window, and does not always give a higher VaR.

  1. AIt eliminates the need to choose a window length because weights decline to zero
  2. BIt can reduce ghost effects relative to equal-weighted simulation because old extreme observations lose weight graduallyCorrect
  3. CIt assumes returns follow a normal distribution with exponentially declining variance
  4. DIt guarantees a higher VaR than equal-weighted historical simulation

Explanation

Equal weighting causes ghost effects: a large loss abruptly drops out when the window passes it. With age weighting the weight of the old loss has already decayed, so the drop is smoother. A window is still needed, and VaR can be higher or lower than the equal-weighted figure.

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