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Answer: The VaR estimates will not be reliable because they are derived from the most current observations of the period that is characterized by higher volatility.
**D is correct.** Bootstrapping is based on observed data and when the present doesn't resemble the past, the estimates are not reliable. Since the current state of the financial market is different from its normal state during a period of notable volatility, the bootstrap may not be reliable. **A is incorrect.** This refers to Monte Carlo simulation. Bootstrapping is based on past observations. It assumes that the present resembles the past, and simulates samples generated from historical data. **B is incorrect.** Applying a bootstrap requires understanding the dependence in the observed data, and it is essential that the bootstrap method used replicates the actual dependence observed in the data. If the bootstrap does not reproduce the dependence, then statistics computed from bootstrapped samples cannot capture the sampling variation in the observed data. Using i.i.d. bootstrapping is only effective when observations are independent through time and it wouldn't make the estimates reliable in this scenario. **C is incorrect.** Simulations generated using IID bootstrapping resembles the historical data. It is especially sensitive to this issue, and a bootstrap sample cannot generate data that did not occur in the sample. This should allow the possibility of future losses that are larger than those that have been realized in the past. Thus, it is usually limited in its ability to generate simulation samples substantially different from what has been already observed.
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A risk analyst uses the bootstrap method to assess the market risk of a global equity portfolio that experienced significant volatility in the recent past. The analyst applies independent and identically distributed (IID) bootstrapping to the extracted standardized residuals of the fitted model, and these bootstrapped standardized residuals are then used to generate time paths of future asset returns. In the final step, the simulated data is used to estimate the VaR of the global equity portfolio over a 1-month horizon. Which of the following will the analyst find to be correct when applying the IID bootstrap method?
A
The VaR estimates will be reliable because they are based on random values generated from an assumed distribution that is not affected by external events or time.
B
The VaR estimates will be reliable because the IID bootstrap fully captures interdependencies in the observed asset return data.
C
The VaR estimates will not be reliable because the IID bootstrap allows the possibility of future losses that are larger than those that have been realized in the past.
D
The VaR estimates will not be reliable because they are derived from the most current observations of the period that is characterized by higher volatility.