CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns
A researcher uses Monte Carlo simulation to value a complex portfolio. Which of the following is the most likely limitation of the result?
The most likely limitation is that results are only as good as the assumed input distributions and parameters. Poor assumptions produce misleading output. Simulation does not need analytical formulas, and adding trials does reduce sampling error, though it cannot fix wrong assumptions.
- AIt is only as accurate as the assumed input distributions and parametersCorrect
- BIt provides answers only when an analytical formula exists
- CIt cannot be made more precise by increasing the number of trials
Explanation
Simulation output depends on the chosen distributions and parameters, so poor assumptions give misleading results. Simulation is useful precisely when no analytical solution exists. More trials reduce sampling error, so precision can be improved.
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