In the case of historical volatility weighted VaR, a higher current volatility when compared to historical volatility:

In the case of historical volatility weighted VaR, a higher current volatility when compared to historical volatility:
A . will not affect the VaR estimate
B . will increase the confidence interval
C . will decrease the VaR estimate
D . will increase the VaR estimate

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Answer: D

Explanation:

When calculating volatility weighted VaR, returns are adjusted by a factor equal to the current volatility divided by the historical volatility, ie the volatility that existed during the time period the returns were earned. If the current volatility is greater than the historical volatility (also called contemporary volatility), then it has the effect of increasing the magnitude of any past returns (whether positive or negative). This in turn increases the VaR.

Consider an example: if the current volatility is 2%, and a return of -5% was earned at a time when the volatility was 0.8%, then the volatility weighted return would be 12.5% (=-5% x 2%/0.8%). Clearly, this has the effect of increasing the VaR. Choice ‘d’ is therefore the correct answer.