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 under stress. Which of the following is the most likely limitation of the approach?
The most likely limitation is that the results depend on the assumed distributions and parameters. If the inputs are poorly specified, the simulated outputs will be misleading, however many trials are run. Monte Carlo can handle options and does not rely only on history.
- AResults depend on the assumed distributions and parametersCorrect
- BIt cannot be applied to portfolios holding options
- CIt requires the use of historical observations only
Explanation
Monte Carlo output is only as good as the input distributions and parameters (the 'garbage in, garbage out' problem). It can handle options and does not need to rely solely on historical data, so the other statements are wrong.
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