Financial Risk Manager Part 1
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In a non-linear portfolio with significant option exposure, which risk metric best captures total portfolio risk?\n\n1. Delta-Normal VaR\n2. Historical Simulation VaR\n3. Monte Carlo VaR\n4. Beta-adjusted VaR
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UAnonymous
A
Delta-Normal VaR
B
Historical Simulation VaR
C
Monte Carlo VaR
D
Beta-adjusted VaR
Explanation:
Monte Carlo VaR is best for non-linear portfolios with significant option exposure because it can fully model the non-linear payoff structure and capture higher-order risks (gamma, vega) by simulating a wide range of market scenarios and revaluing the portfolio under each scenario. Delta-Normal VaR assumes linearity and normal returns which misstates option risk; Historical Simulation VaR may not capture extreme or future volatilities beyond the historical sample; Beta-adjusted VaR is meant for equity portfolios adjusted by beta and doesn't capture option non-linearities.
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