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Massimo.Guidolin@unibocconi.it
Dept. of Finance
FINANCIAL ECONOMETRICS
PROF. MASSIMO GUIDOLIN
SECOND PART, LECTURE 7:
SIMULATION-BASED METHODS
IN RISK MANAGEMENT
Lecture 7: Simulation-Based Methods Prof. Guidolin
OVERVIEW
1) Historical Simulations (IID bootstrap): pros and cons
2) Weighted Historical Simulations
3) Monte Carlo Simulation Methods
4) Filtered Historical Simulation Methods
a.a. 12/13 p. 2
a.a. 12/13 p. 3
If m is too large, then most recent observations, which presumably are most relevant for tomorrows distribution, will carry very
little weight, and the VaR will tend to look very smooth over time
If m is chosen to be too small, then the sample may not include
enough large losses to enable the risk manager to calculate, say, a
1% VaR with any precision
Conversely, the most recent past may be very unusual, so that
tomorrows VaR will be too extreme
AN EXAMPLE
Data
a.a. 12/13 p. 10
Long
Short
HS with m = 5
Long
MC sequences of
simulated returns
between t + 1 and t + K
a.a. 12/13 p. 12
The key advantage of MCS is its flexibility: you can use it for
any assumed distribution of standardized returnsnormality
is not required (here it is just an example)
FH sequences of
simulated returns
between t + 1 and t + K
a.a. 12/13 p. 15
a.a. 12/13 p. 16
Two passes: in the first one pay attention to the results; in the
second start looking at the Matlab code