CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns
An analyst uses Monte Carlo simulation to estimate the value of a portfolio in one year. Which step is most likely performed first?
The analyst first specifies the probability distributions of the risk factors. Random draws can only be generated once the distributions are defined. Computing the trial values and averaging the results are later steps in the Monte Carlo process.
- ASpecify the probability distributions of the risk factorsCorrect
- BCalculate the average of the simulated trial outcomes
- CDraw random values for each risk factor in every trial
Explanation
Before random draws can be made, the analyst must specify the quantity to be valued and the distributions (and correlations) of the risk factors. Drawing values and averaging outcomes come later in the process.
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