Which one of the following is an advantage of using a daily decay factor when...

Comprehensive and Detailed In-Depth Explanation:

A daily decay factor (e.g., in EWMA models) weights recent data more heavily, but gradually reduces the influence of extreme returns over time, smoothing forecasts. Option B is correct—it mitigates the lasting impact of outliers. Option A is incorrect (recent volatility retains influence). Option C reverses the effect, and Option D is unrelated (decay doesn’t target low volatility). GARP’s FRR discusses this in VaR forecasting.

Exact Extract from Official Source:

GARP FRR Study Notes, Market Risk Section: "A decay factor in P&L forecasting, such as in EWMA, reduces the weight of extreme past returns over time, providing a balanced view of volatility."

BCBS, "Basel III: A Global Regulatory Framework," December 2010, para. 718: "Models using decay factors lessen the persistent effect of extreme events on risk estimates."