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 elevated idiosyncratic volatility that broad diversification across many option strikes and expirations would largely eliminate, so the VaR understatement simply reflects an incomplete hedge rather than any feature of the return distribution itself.
3. The VaR figure was understated purely because volatility was estimated using an exponentially weighted scheme that steadily decayed the weight placed on older high-volatility observations, a correctable calibration error a longer, equal-weighted estimation window would have properly fixed.
4. The strategy's daily returns exhibited positive serial autocorrelation that artificially inflated its reported Sharpe ratio measure over time, so scaling the daily VaR figure by the square root of time overstated, rather than understated, the true multi-day horizon risk exposure.

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