Limitations of Beta and VaR in Risk Management

Hard Risk Management Measuring Risk

John is a portfolio manager overseeing a diversified fund with a significant allocation to equities. Recently, he has experienced heightened volatility in the markets, which has raised concerns among his clients about potential risks to their investments. To assess this risk, John decides to analyze his fund’s beta coefficient and the Value at Risk (VaR) methodology.

With the beta coefficient being 1.2, he understands that his fund is expected to be 20% more volatile than the market. He also evaluates the one-month VaR at a 95% confidence level, which indicates the maximum expected loss over one month given normal market conditions.

Considering John's situation, which of the following statements accurately describes a potential limitation of using only beta and VaR for risk management?

Using beta does not account for extreme market movements, which could lead to underestimating potential losses in turbulent periods.

Value at Risk is highly effective in forecasting future returns, making it a reliable tool for all investment strategies.

Both beta and VaR provide real-time analysis of the portfolio's risk profile, which is essential for dynamic management decisions.

Hint

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