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BACK SIMULATION

Discuss BACK SIMULATION within the Financial Management forums, part of the PUBLISH / UPLOAD PROJECT OR DOWNLOAD REFERENCE PROJECT category; HISTORIC or BACK SIMULATION Advantages: Simplicity Does not require normal distribution of returns (which is a critical assumption for RiskMetrics) ...

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Abhijeet S
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BACK SIMULATION - September 3rd, 2010

HISTORIC or BACK SIMULATION

Advantages:
  • Simplicity

  • Does not require normal distribution of returns (which is a critical assumption for RiskMetrics)

  • Does not need correlations or standard deviations of individual asset returns.

  • Basic idea: Revalue portfolio based on actual prices (returns) on the assets that existed yesterday, the day before, etc. (usually previous 500 days).

  • Then calculate 5% worst-case (25th lowest value of 500 days) outcomes.

  • Only 5% of the outcomes were lower.


Weaknesses

Disadvantage: 500 observations is not very many from statistical standpoint.


Increasing number of observations by going back further in time is not
desirable.


Could weight recent observations more heavily and go further back.
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