Thu, Dec 8, 2016
A A A
Welcome Guest
Free Trial RSS
Get FREE trial access to our award winning publications
New Managers March 2013

Peter Urbani' Statistics - Monte Carlo may overestimate individual asset risks by up to two thirds

 

Injudicious use of Monte Carlo simulations could overestimate individual asset risks by two thirds if strict normality is assumed and the shape of the underlying distributions is ignored. Similarly total returns and Sharpe Ratios could be overstated by 20% or more when assuming strict normality. Individual assets that have positively skewed distributions may have their returns under estimated by 13% or more.

Most investors and software do not consider the asymmetry of returns and risks when conducting Monte Carlo simulations of future portfolio returns and simply rely on the central limit theorem to assume normality. Whilst the CLT certainly holds, it does so only over the long-term. In the short run, things may be very different indeed.

This month we look at the three main methods of generating correlated random deviates for the purposes of performing Monte Carlo simulations, namely;

  • The Cholesky Method,
  • The Spectral ( SVD ) Method and,
  • The Inverse method

As you may know, Monte Carlo simulations were invented by Stanislaw Ulam and John von Neumann during their work on the Manhattan project. The requirement for significant computing power meant that the method remained the preserve of think tanks, large universities and corporations until around the the 1980s and the advent of the Personal Computer. Since then, the use of the method has exploded and it has become ubiquitous in finance and financial planning even to the detriment of stopping people from trying to find closed form solutions for some problems which may have them.

Thanks to Moore’s law, most of us now have sufficient computing pow......................

To view our full article please login

This article was published in Opalesque's New Managers a top-down monthly analysis, news and research publication on the global emerging manager space.
New Managers
New Managers
New Managers

Today's Exclusives Today's Other Voices More Exclusives
Previous Opalesque Exclusives                                  
More Other Voices
Previous Other Voices                                               
Access Alternative Market Briefing

 



  • Top Forwarded
  • Top Tracked
  • Top Searched
  1. M&A - AllianzGI to acquire Sound Harbor Partners, SS&C completes acquisition of Wells Fargo's Global Fund Services business[more]

    AllianzGI to acquire Sound Harbor Partners Allianz Global Investors (AllianzGI), an active investment manager, announced that Sound Harbor Partners, a US private credit manager led by Michael Zupon and Dean Criares, have agreed to join its fast-growing Private Debt Platform. Under the te

  2. Hunt for yield pushes more investors into riskier assets[more]

    From FT.com: Pension funds and insurance companies have increasingly embraced riskier assets in their hunt for higher returns over the past five years. Alternative assets such as property, infrastructure, private equity and hedge funds have been bought up by institutional investors in a world where

  3. People - Nectar Financial hires senior investment team, Texas A&M replaces retiring foundation investment chief, Ex-Cadwalader partner Woolery makes another sudden exit, How to become a Python coder at a top hedge fund, by the co-CTO of Man AHL[more]

    Nectar Financial hires senior investment team Nectar Financial AG, a Swiss financial technology company for wealth and asset management, has announced that it has hired two key senior leaders to spearhead its digital asset management efforts. The company also announced that it has entere

  4. Activist News - Cognizant has introductory discussion with activist investor Elliott; to review letter, Starboard Value makes huge investment in Hewlett Packard, Hedge fund calls for removal of First NBC Bank CEO[more]

    Cognizant has introductory discussion with activist investor Elliott; to review letter From Indiatimes.com: Cognizant said it had an introductory discussion with Elliott Management after receiving the activist hedge fund's letter asking for a board shakeup, a buyback, a dividend and chan

  5. Opalesque Exclusive: Ireland relaxes treatment of direct lending funds[more]

    Bailey McCann, Opalesque New York: The Irish Central Bank has relaxed its treatment of direct lending funds, according to a recently released