medium · FRM Part 1 Quantitative Analysis
If a correlation matrix is NOT positive semidefinite, what is the consequence for a Cholesky-based Monte Carlo simulation?
- The standard error of the resulting VaR estimate will mathematically become infinite under this condition.
- The simulation will still run to completion but will silently generate zero correlation between all asset pairs.
- The algorithm will fail because it would require taking the square root of a negative number.
- The resulting portfolio variance from the simulated paths will always converge to exactly one.
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