All of the following occurrences are examples of risk mismeasurement, except when risk managers:
A. do not understand the distribution of returns of a single risky position.
B. do not understand the relationships of the distributions among different positions.
C. fail to take known and unknown risks into account.
D. fail to use subjectivity when measuring extreme and rare events.
Answer:D
Risk mismeasurement can occur when risk managers do not understand the distribution of returns of a single risky position or the relationships of the distributions among different positions. One of the key issues for risk managers is the occurrence of extreme events (those events which occur with low frequency, but high severity). Estimates of these rare events require a degree of subjectivity, which clearly has the potential for mismeasurement. Risk mismeasurement can also occur from ignoring relevant risks.