CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns
Compared with historical simulation, Monte Carlo simulation is most likely:
Monte Carlo simulation depends on assumed distributions and parameters for the risk factors. Its results are only as good as those inputs. Unlike historical simulation, it can produce scenarios never observed in the data, but random generation does not remove model risk.
- Alimited to scenarios that have already occurred in the data
- Bdependent on assumed distributions and parameters for the risk factorsCorrect
- Cfree of model risk because it uses randomly generated values
Explanation
Monte Carlo draws from assumed distributions with estimated parameters, so results depend on those assumptions. It can generate scenarios beyond those observed, unlike historical simulation, and it still carries model risk.
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