Which of the following statements about parametric and nonparametric methods for calculating Value-at-risk is correct?

Which of the following statements about parametric and nonparametric methods for calculating Value-at-risk is correct?
A . Parametric methods generally assume returns are normally distributed, and non-parametric methods make no assumptions about return distributions.
B . Parametric methods make no assumptions about return distributions, and non-parametric methods assume returns are normally distributed.
C . Both parametric and nonparametric methods assume returns are normally distributed.
D . Both parametric and nonparametric methods make no assumptions about return distributions.

View Answer

Answer: A

Explanation:

Value-at-Risk (VaR) can be calculated using either parametric or non-parametric methods. Parametric methods, such as the variance-covariance approach, typically assume that returns follow a normal distribution. This assumption simplifies the calculations but may not always accurately reflect the true distribution of returns, especially in the presence of skewness and kurtosis.

On the other hand, non-parametric methods, such as historical simulation or Monte Carlo simulation, do not make any assumptions about the distribution of returns. Instead, they rely on actual historical return data or simulated data to estimate the VaR, allowing for more flexibility and potentially more accurate risk assessments in cases where the return distributions deviate significantly from normality.