medium · FRM Part 2 Risk & Investment Management
A portfolio contains a large allocation to a private real estate fund with reported correlation to equities of 0.20 and a first-order autocorrelation of 0.45.
If the risk system applies a 'lag-adjustment' that triples the reported correlation to reflect economic reality, what is the impact on the portfolio's diversified 99% VaR if the real estate position is $100 million and its reported daily volatility is 0.50%?
- VaR decreases due to the higher diversification benefit of the 0.60 correlation.
- VaR increases solely due to the correlation change, as the volatility adjustment is only used for capital, not VaR.
- VaR remains unchanged because unsmoothing only affects the asset's standalone risk, not its contribution.
- VaR increases because both true volatility and true correlation are higher than reported.
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