Historical Scenarios with Fully Flexible Probabilities
SYMMYS; Kepos Capital
October 23, 2010
GARP Risk Professional, pp. 47-51, December 2010
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.
Number of Pages in PDF File: 15
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, G11working papers series
Date posted: November 14, 2010 ; Last revised: May 18, 2011
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