A portfolio manager for a Canadian Pension Fund has been asked to assess the risk of a new alternative investment with a highly skewed return distribution. Which risk measure would be most appropriate given the non-normal distribution, and why?

Question: A portfolio manager for a Canadian Pension Fund has been asked to assess the risk of a new alternative investment with a highly skewed return distribution. Which risk measure would be most appropriate given the non-normal distribution, and why?

Answer options:

• Standard Deviation, because it is widely understood and easy to calculate for any dataset.
• Beta, as it measures systematic risk and indicates market sensitivity. ✅ Conditional Value at Risk (CVaR), because it accounts for the magnitude of losses beyond the VaR threshold.
• Sharpe Ratio, as it measures risk-adjusted return and is suitable for all distributions.

Correct answer: Conditional Value at Risk (CVaR), because it accounts for the magnitude of losses beyond the VaR threshold.

Explanation: For highly skewed return distributions, Conditional Value at Risk (CVaR) is more appropriate than VaR because it captures the expected loss in the tail of the distribution, beyond the VaR threshold, which is crucial for non-normal returns.