CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns
A risk manager uses Monte Carlo simulation to estimate the 1-day 5% value at risk of a portfolio. Which of the following is the most likely description of the result?
The simulated 5% value at risk is the loss threshold that is exceeded in about 5% of the simulated outcomes, i.e., the 5th percentile of the simulated return distribution. It is not the average loss or the worst simulated loss.
- AThe loss threshold exceeded in about 5% of simulated outcomesCorrect
- BThe average loss across all simulated outcomes
- CThe largest loss observed in the simulation
Explanation
VaR at 5% is the loss level that is exceeded in 5% of outcomes, found as the 5th percentile of the simulated portfolio return distribution. It is neither the mean nor the maximum loss.
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