CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns
A simulation of a pension fund's asset values uses inputs estimated from a short, calm period in markets. The limitation most likely to affect the results is that:
The main limitation is that simulation results depend on input assumptions, so parameters from a short, calm period can understate volatility and tail risk. More trials reduce sampling error only; they cannot correct unrepresentative inputs or a misspecified model.
- Athe output can understate risk if inputs are unrepresentativeCorrect
- Bsimulation cannot produce a distribution of outcomes
- Cmore trials always remove input estimation error
Explanation
Simulation output is only as good as its inputs and assumptions. Calm-period inputs can understate volatility and tail risk, and increasing trials reduces sampling error but not input error.
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