6. Simulation Methods

Question 1

Bootstrap

Answer 1

A resampling method that repeatedly draws samples with replacement of the selected elements from the original observed sample. Bootstrap is usually conducted by using computer simulation and is often used to find standard error or construct confidence intervals of population parameters.

Question 2

Contingent claim

Answer 2

A type of derivative in which one of the counterparties determines whether and when the trade will settle. An option is a common type of contingent claim.

Question 3

Monte Carlo simulation

Answer 3

A technique that uses the inverse transformation method for converting a randomly generated uniformly distributed number into a simulated value of a random variable of a desired distribution. Each key decision variable in a Monte Carlo simulation requires an assumed statistical distribution; this assumption facilitates incorporating non-normality, fat tails, and tail dependence as well as solving high-dimensionality problems.

Question 4

Resampling

Answer 4

A statistical method that repeatedly draws samples from the original observed data sample for the statistical inference of population parameters.

Question 5

Volatility

Answer 5

The standard deviation of the continuously compounded returns on the underlying asset.