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CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns

A pension fund uses simulation to assess whether its assets will cover future liabilities under many interest rate and return scenarios. A key limitation of this application is that the results are most likely:

Simulation results depend on the quality of the assumptions and input distributions. Poorly specified return, rate or correlation assumptions give misleading output, and events outside the assumed distributions will not appear, so the technique provides approximations rather than guarantees.

  1. Aonly valid if every simulated path is identical.
  2. Bdependent on the quality of the assumptions and input distributions.Correct
  3. Cguaranteed to capture events outside the assumed distributions.

Explanation

Simulation output is only as good as the model and inputs (garbage in, garbage out). It gives approximate, not exact, answers and cannot generate events that the assumed distributions rule out.

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