Historical Simulation

Historical simulation is a risk management method used to estimate the potential future performance of an asset or portfolio based on historical price data. This method assumes that past market conditions and price movements are a good proxy for future performance. Historical simulation is often used in Value at Risk (VaR) calculations, where it models potential losses based on past volatility and price trends.However, the method's reliance on historical data may limit its effectiveness in predicting future risks during unprecedented market events.

Example

A financial institution uses historical simulation to estimate the Value at Risk (VaR) for its portfolio by analyzing historical price movements and volatility patterns.