hard · FRM Part 2 Market Risk
A bank employs 'Cornish-Fisher' expansion to adjust its VaR for non-normal skewness and kurtosis. A validator discovers that for a very deep quantile (99.975%) and high positive skewness, the 'adjusted' VaR is actually lower than the 99% VaR.
What is the likely cause of this result?
- The bank should have used 'Age-Weighted' simulation instead, which would correct the 'ghost effects' behind this non-monotonic result.
- The model has correctly identified 'Right-Way Risk,' where extreme outcomes lead to a reduction in the bank's total exposure.
- The Cornish-Fisher expansion can become 'non-monotone' at extreme quantiles or high moments, leading to nonsensical probability mappings.
- The 'Central Limit Theorem' has failed to converge because of 'jump-diffusion' behavior present in the underlying market risk factors.
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