Explanation:
B is correct. Filtered historical simulation accommodates conditionally changing volatility, volatility clustering, and allows for the “leverage effect”, a phenomenon where positive and negative returns have differing impacts on volatility.
A is incorrect. The correlation-weighted historical simulation approach uses a variance-covariance matrix to adjust the returns in the data set. This is more complex than the volatility-weighted approach, which simply multiplies each return by the current volatility estimate divided by the historical volatility estimate.
C is incorrect. Volatility-weighted HS increases (decreases) a historical return observation if the current forecast of volatility is greater (less) than the historical forecast of volatility corresponding with the historical return observation.
D is incorrect. Age-weighted HS allows the risk management practitioner to choose a value of lambda that represents the exponential rate of decay in the weight given to an observation as it ages. This approach does not assume that the decay is linear.
A
The correlation-weighted HS approach adjusts the return observations by multiplying each return by the current correlation divided by the historical correlation.
B
The filtered HS approach accommodates volatility clustering and allows positive and negative returns to impact volatility differently.
C
The volatility-weighted HS approach adjusts returns upward when the current volatility is below the long-term average volatility.
D
The age-weighted HS approach assumes that the value of the information contained in a return observation declines in a linear manner starting from the date it is first observed.
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