CFA Level I · CFA Level I Exam · Simulation of Financial Asset Prices and Returns
In a Monte Carlo simulation, an analyst wants to cut the standard error of the estimated mean by half. Holding other inputs constant, the number of trials must most likely be:
The number of trials must be quadrupled. Monte Carlo standard error falls with the square root of the number of trials, so halving the error requires the square root of n to double, meaning four times as many trials. Doubling gives only about a 29% reduction.
- Adoubled.
- Bquadrupled.Correct
- Cincreased eightfold.
Explanation
Standard error is proportional to 1/sqrt(n). Halving it requires sqrt(n) to double, so n must be four times larger. Doubling the trials reduces the error only by a factor of about 0.707.
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