Explanation:
The correct answer is B.
In risk management and the process of mapping, selecting primitive risk factors involves a trade-off. Using a large number of risk factors generally yields a higher quality of approximation and more precise risk measurement but requires a larger covariance matrix and more complex computations. On the other hand, using fewer factors leads to a less complex model that is faster to process and requires less data, but it may sacrifice precision. Therefore, the choice of primitive risk factors directly reflects the trade-off between employing models with a large number of factors (higher accuracy, higher complexity) versus less complex models (lower accuracy, lower complexity).
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Q.1514 In the process of mapping, finance experts first need to choose the most effective set of primitive risk factors against which the market instrument will be positioned to measure risk. This choice of factors must be balanced between time devotion and accurate risk measurement. In short, the choice of primitive risk factors should reflect:
A
The easiest way to get better results in the least amount of time.
B
The trade-off between models with a large number of factors and less complex models.
C
The trade-off between better quality of approximation and faster processing.
D
The trade-off between specific risks with significant effects and those with insignificant effects.
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