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

An analyst runs a bootstrap using 5 years of returns that include no market crisis. The resulting estimate of the 1% worst-case loss is most likely:

The estimate is most likely understated. Bootstrap draws only from observed returns, so if the five-year sample contains no crisis, severe losses cannot appear in any resample. The method inherits the limitations of the data and cannot reveal tail risks absent from it.

  1. Aunderstated because extreme outcomes absent from the sample cannot be drawnCorrect
  2. Boverstated because resampling with replacement inflates the variance
  3. Cunbiased because resampling removes the dependence on the sample period

Explanation

Bootstrap can only reproduce observed values, so if the sample lacks crisis returns, tail losses will be understated. Resampling with replacement does not systematically inflate variance. The result still depends heavily on the sample, so it is not free of sample-period dependence.

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