Financial Risk Manager Part 1
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Consider the following basic steps involved when conducting a Monte Carlo simulation:
I. Carry out regression and calculate the test statistic II. Generate the data following the desired data generation process, drawing the errors from some given distribution III. Save the test statistic or the parameter of interest IV. Go back to stage 1 and repeat N times
Which of the following is the correct order of the steps above?
Other
Community
NNikitesh
A
I, II, III, IV
B
I, III, II, IV
C
II, I, III, IV
D
II, I, IV, III
Explanation:
The correct order for Monte Carlo simulation is:
- Generate the data following the desired data generation process (Step II)
- Carry out regression and calculate the test statistic (Step I)
- Save the test statistic or the parameter of interest (Step III)
- Repeat the process N times (Step IV)
This sequence makes logical sense because:
- First, you need to generate the simulated data according to your model specification
- Second, you perform the statistical analysis (regression) on that generated data
- Third, you record the results of that analysis
- Finally, you repeat the entire process multiple times to build a distribution of results
The provided explanation confirms this order: "When conducting a Monte Carlo simulation, the first stage entails specifying the model to use to generate the data... Second, the parameter of interest is estimated through regression... Third, the parameter of interest or the test statistic is saved. Finally, these steps are repeated N times..."
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