CRO Quantitative Risk Modeling & Analytics Flashcards

Which statistical measure is MOST commonly used to express the potential maximum loss of a portfolio over a given confidence interval and time horizon?

Answer: Value at Risk (VaR)

Value at Risk (VaR) quantifies the maximum potential loss at a specified confidence level over a defined time period and is the industry standard risk measure for portfolios.

A CRO is concerned that VaR underestimates tail risk. Which complementary measure should be used?

Answer: Expected Shortfall (CVaR)

Expected Shortfall (CVaR) measures the average loss beyond the VaR threshold, providing a more complete picture of tail risk that VaR ignores.

Monte Carlo simulation is used in risk modeling primarily to:

Answer: Generate thousands of possible future scenarios to estimate the probability distribution of outcomes

Monte Carlo simulation runs large numbers of random scenario iterations to model complex, non-linear risk distributions that analytical formulas cannot easily capture.

What is the primary limitation of using historical simulation for VaR calculations?

Answer: It assumes that the future will mirror past market conditions and may miss novel risk events

Historical simulation relies entirely on past data, so it will fail to capture unprecedented market dislocations or structural changes not present in the historical window.

In quantitative risk modeling, 'model risk' refers to:

Answer: The potential for incorrect decisions arising from errors or misuse of quantitative models

Model risk is the risk of adverse consequences resulting from inaccurate models, flawed assumptions, or inappropriate application of a model to a given problem.

A correlation coefficient of +1.0 between two asset classes in a risk model implies:

Answer: The assets always move perfectly together in the same direction

A correlation of +1.0 means the two assets move in perfect lockstep in the same direction, providing no diversification benefit in a combined portfolio.