medium · FRM Part 2 Market Risk
A 10-day 99% VaR is being estimated from a 1-day VaR of $2 million.
If the returns exhibit strong volatility clustering (GARCH effects) and today is a particularly calm day, what is the likely bias in using the 'square-root-of-time' rule?
- It will remain unbiased as long as the underlying mean return is assumed to equal zero.
- It will likely understate the true 10-day risk because it fails to account for the persistence of volatility shocks.
- It will likely overstate the risk because the Central Limit Theorem thins the tails of the aggregated return distribution.
- It will understate the risk only in the specific case where the returns exhibit a positive drift.
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