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Answer: Assume that a group of market variables change as they did during one of the days in a historical reference period, and apply these changes to the current values of these variables, which are then used to calculate asset values.
## Explanation **A is correct** because this accurately describes the historical simulation approach. Historical simulation involves: 1. Identifying market variables (risk factors) that affect the portfolio value 2. Collecting historical data on these risk factors over a reference period 3. Creating scenarios by applying historical changes in risk factors to current market values 4. Calculating asset values based on these adjusted risk factors **B is incorrect** because historical simulation models movements in underlying risk factors, not direct percentage changes in asset values themselves. **C is incorrect** because this describes Monte Carlo simulation, which assumes multivariate normal distributions and random sampling, rather than using actual historical changes. **D is incorrect** because this also describes Monte Carlo simulation and directly models asset value movements rather than using risk factor changes.
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A risk analyst at a pension fund is using the historical simulation approach to calculate the 1-day ES of a portfolio of assets. The analyst begins by generating a set of 250 scenarios for the portfolio. Which of the following assumptions or procedures correctly describes the most appropriate way for the analyst to generate asset values for each of the scenarios used in the historical simulation?
A
Assume that a group of market variables change as they did during one of the days in a historical reference period, and apply these changes to the current values of these variables, which are then used to calculate asset values.
B
Assume that the values of the assets in the portfolio experience the same percentage change as they did during one of the days in a historical reference period.
C
Assume that a group of market variables has a multivariate normal distribution based on their movements during a historical reference period, and use a sampled value from this distribution to calculate asset values.
D
Assume that the values of the assets in the portfolio have a multivariate normal distribution based on their movements during a historical reference period, and then sample once from this distribution of asset values.
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