Historical Scenarios with Fully Flexible Probabilities

GARP Risk Professional, pp. 47-51, December 2010

15 Pages Posted: 14 Nov 2010 Last revised: 18 May 2011

See all articles by Attilio Meucci

Attilio Meucci

ARPM - Advanced Risk and Portfolio Management

Date Written: October 23, 2010

Abstract

After reviewing the parametric and scenario-based approaches to risk management, we discuss a methodology to enhance the flexibility of the scenario-based approach. We change the probability of each scenario, and then we compute the ensuing p&l distribution and all relevant statistics such as VaR and volatility. The probabilities can be changed to reflect specific market conditions, advanced estimation techniques, or partial information, using the entropy-based Fully Flexible Views technique. The implementation of this approach is trivial, as no costly repricing is needed. Commented code is available at symmys.com.

Keywords: Exponential Smoothing, Kernel Smoothing, Parametric VaR, Monte Carlo Simulations, Stress-Test, Fully Flexible Views, Entropy Pooling, Multivariate Histogram, Empirical Distribution, Dirac Delta, Kullback-Leibler Divergence

JEL Classification: C1, G11

Suggested Citation

Meucci, Attilio, Historical Scenarios with Fully Flexible Probabilities (October 23, 2010). GARP Risk Professional, pp. 47-51, December 2010, Available at SSRN: https://ssrn.com/abstract=1696802 or http://dx.doi.org/10.2139/ssrn.1696802

Attilio Meucci (Contact Author)

ARPM - Advanced Risk and Portfolio Management ( email )

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