Thu, Jun 29, 2017
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

Â

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. Legal - Bond market concerns could scuttle Paulson's Fannie-Freddie plan[more]

    From Bloomberg.com: A hedge fund proposal for freeing Fannie Mae and Freddie Mac from U.S. control is poised to face stiff opposition from investors who say it risks wrecking the mortgage-bond market. The Moelis & Co. blueprint, which firms including Paulson & Co. and Blackstone Group LP sponsored,

  2. Other Voices: Are your pricing policies and procedures for less liquid instruments adequate?[more]

    Komfie Manalo, Opalesque Asia: The unrelated position mismarking incidents that quickly precipitated the closures of both Visium Asset Management and Marinus Capital have been recent focal points for market participants, but regulatory scrutiny of valuation choices for less liquid instruments is

  3. FinTech - AI hedge fund Numerai now live on Ethereum, Cryptocurrency hedge funds generate huge returns as bitcoin surges[more]

    AI hedge fund Numerai now live on Ethereum From Cryptoninjas.net: Back in February, Numerai announced numeraire (NMR), a cryptographic token to incentivize a new kind of hedge fund built by a network of data scientists. Earlier today, the Numeraire smart contract was officially deployed

  4. Investing - Advisors slash hedge fund positions, Theravance Biopharma is a top pick of investment guru Seth Klarman, As asset management industry grows a search for new revenue streams[more]

    Advisors slash hedge fund positions From Barrons.com: Financial advisors have cut wealthy clients' exposure to hedge funds by up to one third over the past 12 months, The Financial Times reports. Advisor firms in the FT's annual top-300 ranking have reduced their hedge fund allocation to

  5. Investing - U.S. hedge fund in anonymous bet against Tesco shares, Hedge funds made repeated attempts to invest in Veneto banks, Steve Cohen's Point72 takes stake in struggling electronics retailer Conn's, Hedge fund Excalibur bets Riksbank will tighten by end of year[more]

    U.S. hedge fund in anonymous bet against Tesco shares From FT.com: A $20bn New York hedge fund is using an offshore shell company to anonymously bet against the shares of the UK supermarket Tesco, raising fresh questions over the efficacy of European short selling disclosure rules.