Explanation:
The correct answer is B.
In a factor model used for Value at Risk (VaR), the total risk of a portfolio or asset is decomposed into systematic (general) risk and specific (idiosyncratic) risk. When more general risk factors are added to the model, they explain a greater portion of the asset's return variations. As a result, the residual variance, which represents the specific risk, decreases. Therefore, adding more general risk factors decreases the size of specific risks.
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Q.2644 Adding more general risk factors to a VaR model will most likely:
A
Increase the size of specific risks.
B
Decrease the size of specific risks.
C
Have no effect on the size of specific risks.
D
While adding more factors to a model will affect the size of specific risk it is not possible to determine the exact nature of the change without considering what factors are added.
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