CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns
An analyst increases the number of Monte Carlo trials from 1,000 to 100,000 to value a derivative. This change will most likely:
Increasing the number of trials will most likely reduce sampling error in the estimate. It does not fix a misspecified distribution or remove the need for correlation assumptions, because those are model inputs rather than a function of the number of trials.
- Acorrect errors in the assumed return distribution
- Breduce sampling error in the estimateCorrect
- Cremove the need to specify correlations between risk factors
Explanation
More trials reduce sampling error, which shrinks roughly with the square root of the number of trials. They cannot fix a wrongly specified distribution or replace the need for correlation assumptions.
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