Mon, Aug 31, 2015
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. Investing - Hedge funds suddenly find real money is back in Argentina's debt, Elon Musk buys more SolarCity stock following hedge fund manager short, BlackRock plans to get into rental-home financing[more]

    Hedge funds suddenly find real money is back in Argentina's debt From Bloomberg.com: The real money is back in Argentina. Before the country’s default in July 2014 (its second in 13 years), most long-term investors abandoned its bond market. As they rushed out, Argentina became a favorit

  2. Activist News - Carl Icahn has snapped up a huge stake in Freeport-McMoRan, and the stock is ripping, Meet Europe's best activist investor[more]

    Carl Icahn has snapped up a huge stake in Freeport-McMoRan, and the stock is ripping From Businessinsider.com: Carl Icahn has picked his next target: Freeport-McMoRan. Icahn and a group of other investors have snapped up an 8.46% stake in mining company Freeport-McMoRan, according to a j

  3. North America - Hedge fund manager Ray Dalio’s challenge to the Fed[more]

    From Newyorker.com: For some reason, Janet Yellen, the chair of the Federal Reserve, decided to skip this year’s annual Fed conference in Jackson Hole, where monetary policymakers from the United States and abroad get together with some prominent academics to discuss the big issues of the moment. Th

  4. Opalesque Exclusive: Credit-focused hedge fund Numen Capital expects more volatility in Europe in coming months[more]

    Benedicte Gravrand, Opalesque Geneva: A London-based hedge fund, which has just hired two emerging managers, is cautious on Europe. Vassilis Paschopoulos and former Lehman’s colleague Nikos Kargadouris, launched a London-based credit-focused hedge fund called

  5. Performance - Hedge funds bruised by stocks’ meltdown, Capstone’s volatility hedge fund is having a monster month thanks to market mayhem[more]

    Hedge funds bruised by stocks’ meltdown From WSJ.com: Hedge-fund managers like to promise their investors protection from market swings. In the recent stock swoon, many were caught off guard. Billionaire managers such as Leon Cooperman, Raymond Dalio and Daniel Loeb are deeply in the red

 

banner