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

Which statement best describes a limitation or feature of the age-weighted (BRW) historical simulation approach compared with equal-weighted historical simulation?

It reduces ghost effects. Because weights decline gradually with age, an old extreme loss loses influence smoothly instead of abruptly leaving the window and causing a sudden VaR jump, as in equal-weighted historical simulation. The method is still non-parametric and still needs a window.

  1. AIt reduces the effect of ghost effects, because old extreme observations lose weight gradually rather than dropping out suddenlyCorrect
  2. BIt eliminates the need to choose a window length
  3. CIt assumes returns are normally distributed
  4. DIt makes VaR independent of the most recent observations

Explanation

With decaying weights, an old extreme loss's influence fades smoothly, reducing the abrupt jump in VaR when it leaves the window (ghost effect). The window length still matters, particularly for small lambda. The method remains non-parametric, so no normality is assumed.

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