hard · FRM Part 1 Foundations of Risk Management

From a risk-typology standpoint, which characterization most accurately captures why standard daily VaR consistently understated this strategy's risk, despite the VaR model being correctly calibrated to the realized return history?

1. The strategy's payoff is short negative convexity, so its loss distribution is left-skewed with a thin body and a fat left tail that a quantile measure within its normal coverage window structurally fails to capture, and the realized history simply had not yet sampled the tail event.
2. The strategy carries high idiosyncratic volatility that diversification across many strikes would eliminate, so the VaR understatement reflects an incomplete hedge rather than any feature of the return distribution itself.
3. The VaR was understated purely because volatility was estimated with an exponentially weighted scheme that decayed the weight on older high-volatility observations, a calibration error that a longer equal-weighted window would have corrected.
4. The strategy's returns exhibited positive autocorrelation that inflated the Sharpe ratio, so scaling daily VaR by the square root of time overstated rather than understated the true horizon risk.

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