Explanation:
The correct answer is A.
The Tracking Error Value at Risk (TE-VaR) is a measure of the maximum potential deviation between the portfolio and the benchmark index under normal market conditions. In this case, the TE-VaR of 0.63 million implies that the maximum deviation between the index and portfolio A is at most 0.63 million under normal market conditions. This is a measure of the risk of underperformance relative to the benchmark. It is important to note that 'normal market conditions' refer to the usual, everyday fluctuations in the market, not extreme events or crises. The TE-VaR is a critical tool for portfolio managers as it helps them understand the potential risk of their portfolio underperforming the benchmark, allowing them to make informed decisions about risk management and asset allocation.
Choice B is incorrect. The TE-VaR does not represent the minimum deviation between the index and portfolio A under normal market conditions. Instead, it represents a worst-case scenario or maximum deviation that could occur under normal market conditions with a certain level of confidence.
Choice C is incorrect. The TE-VaR does not signify the maximum deviation under abnormal market conditions. It is calculated based on normal market conditions and therefore cannot be used to predict deviations in abnormal or extreme scenarios.
Choice D is incorrect. Similar to choice B, TE-VaR does not represent the minimum deviation between the index and portfolio A, especially not under abnormal market conditions which are outside its calculation parameters.
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Q.1517 Benchmarking is the process of evaluating a portfolio’s risk against some standard or ideal portfolio risk that is considered as the benchmark. Therefore, the VaR of the deviation of portfolio A relative to the benchmark is
Tracking Error VaR = α√(x − x₀)′Σ(x − x₀)
After we performed the necessary calculations for portfolio A, we found the tracking error VaR of portfolio A which is 0.63 million. What does this tracking error VaR value imply?
A
The maximum deviation between the index and portfolio A is at most 0.63 million under normal market conditions.
B
The minimum deviation between the index and portfolio A is at most 0.63 million under normal market conditions.
C
The maximum deviation between the index and portfolio A is at most 0.63 million under abnormal market conditions.
D
The minimum deviation between the index and portfolio A is at most 0.63 million under abnormal market conditions.