medium · FRM Part 1 Valuation and Risk Models

In a multivariate Delta-Gamma VaR, what role does the covariance matrix (Σ) play?

1. It serves as the decay factor (lambda) that anchors an EWMA volatility model used to update variance estimates continuously over time.
2. It calculates the risk-neutral probabilities (p) that get used when constructing and calibrating the binomial pricing tree model.
3. It is the primary statistical tool used for eliminating so-called 'ghosting' effects that arise only within historical simulation windows.
4. It provides the joint probabilities of price changes (δ S_i, δ S_j) that interact with the vector of deltas and the matrix of gammas.

Sign up free to see the explanation and track your rank →