medium · Frm Part 2 Market Risk
An analyst is evaluating two business units. Unit A has a high standalone VaR but its returns are negatively correlated with the firm's main portfolio. Unit B has a lower standalone VaR but is highly correlated with the main portfolio.
Which unit will likely have a higher Component VaR?
- Both will be equal if their contribution to total revenue is the same.
- Unit B, because its high correlation prevents diversification benefits.
- Unit A, because standalone VaR is the primary driver of capital allocation.
- Unit A, because negative correlation indicates higher volatility relative to the benchmark.
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