{"id":22826,"date":"2021-11-09T20:43:26","date_gmt":"2021-11-09T20:43:26","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=22826"},"modified":"2026-06-23T09:12:53","modified_gmt":"2026-06-23T09:12:53","slug":"historical-scenario-analysis","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/historical-scenario-analysis\/","title":{"rendered":"Historical Scenario Analysis"},"content":{"rendered":"<p><script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"ImageObject\",\r\n  \"url\": \"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes-1536x1351.jpg\",\r\n  \"contentUrl\": \"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes-1536x1351.jpg\",\r\n  \"caption\": \"Sharpe Ratio in Different Volatility Regimes\",\r\n  \"width\": 1536,\r\n  \"height\": 1351,\r\n  \"representativeOfPage\": true,\r\n  \"associatedArticle\": {\r\n    \"@type\": \"WebPage\",\r\n    \"@id\": \"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/historical-scenario-analysis\/\"\r\n  },\r\n  \"copyrightNotice\": \"\u00a9\u202f2024 AnalystPrep\",\r\n  \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\r\n  \"creditText\": \"AnalystPrep Design Team\",\r\n  \"creator\": { \"@type\": \"Organization\", \"name\": \"AnalystPrep\" }\r\n}\r\n<\/script> <script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"ImageObject\",\r\n  \"url\": \"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies-1536x1351.jpg\",\r\n  \"contentUrl\": \"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies-1536x1351.jpg\",\r\n  \"caption\": \"Sharpe Ratio in Different Economic Scenarios\",\r\n  \"width\": 1536,\r\n  \"height\": 1351,\r\n  \"representativeOfPage\": false,\r\n  \"associatedArticle\": {\r\n    \"@type\": \"WebPage\",\r\n    \"@id\": \"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/historical-scenario-analysis\/\"\r\n  },\r\n  \"copyrightNotice\": \"\u00a9\u202f2024 AnalystPrep\",\r\n  \"acquireLicensePage\": \"https:\/\/analystprep.com\/license-info\",\r\n  \"creditText\": \"AnalystPrep Design Team\",\r\n  \"creator\": { \"@type\": \"Organization\", \"name\": \"AnalystPrep\" }\r\n}\r\n<\/script> <script type=\"application\/ld+json\">\r\n[\r\n  {\r\n    \"@context\": \"https:\/\/schema.org\",\r\n    \"@type\": \"QAPage\",\r\n    \"mainEntity\": {\r\n      \"@type\": \"Question\",\r\n      \"name\": \"Historical Scenario Analysis - Portfolio Skewness and Kurtosis\",\r\n      \"text\": \"Mark Jayden conducted a historical scenario analysis to examine the effect of regime changes on his portfolio. He observed that the portfolio had negative skewness and a fat tail to the left in a recession regime. Which of the following is the conclusion that Jayden will most likely make about his portfolio?\\n\\nA. Lower average returns.\\nB. Higher average returns.\\nC. Cannot be determined.\",\r\n      \"answerCount\": 3,\r\n      \"acceptedAnswer\": {\r\n        \"@type\": \"Answer\",\r\n        \"text\": \"Lower average returns.\",\r\n        \"upvoteCount\": 0,\r\n        \"commentCount\": 0\r\n      },\r\n      \"suggestedAnswer\": [\r\n        {\r\n          \"@type\": \"Answer\",\r\n          \"text\": \"Higher average returns.\",\r\n          \"upvoteCount\": 0,\r\n          \"commentCount\": 0\r\n        },\r\n        {\r\n          \"@type\": \"Answer\",\r\n          \"text\": \"Cannot be determined.\",\r\n          \"upvoteCount\": 0,\r\n          \"commentCount\": 0\r\n        }\r\n      ]\r\n    }\r\n  }\r\n]\r\n<\/script><\/p>\r\n<p>&nbsp;<\/p>\r\n\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/FqQEumbr5is\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\r\n<p><strong>Historical scenario analysis<\/strong> is a form of backtesting that examines the risk and performance of an investment strategy at different structural breaks and structural regimes. The most common types of <strong>regime changes<\/strong> are from economic expansion to recessions and from high-volatility to low-volatility.<\/p>\r\n<ol>\r\n\t<li><strong>High-volatility and low-volatility regimes:<\/strong> To illustrate this, we will use the VIX index, which gauges options implied volatility on the S&amp;P 500 index. A five-year moving average will be computed to convert the VIX into a volatility regime indicator. The periods when the VIX is below its five-year moving average are the low-volatility regime periods.<br \/>\r\n<div style=\"text-align: center; margin: 28px 0;\"><a style=\"display: inline-block; background: #1a73e8; color: #ffffff; padding: 12px 26px; border-radius: 40px; font-size: 16px; font-weight: 500; text-decoration: none; line-height: 1.4;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Learn Volatility Regimes with our Free Trial <\/a><\/div>\r\n<img loading=\"lazy\" decoding=\"async\" class=\"aligncenter size-full wp-image-26673\" src=\"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes.jpg\" alt=\"\" width=\"1590\" height=\"1399\" srcset=\"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes.jpg 1590w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes-300x264.jpg 300w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes-1024x901.jpg 1024w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes-768x676.jpg 768w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes-1536x1351.jpg 1536w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Volatility-Regimes-400x352.jpg 400w\" sizes=\"auto, (max-width: 1590px) 100vw, 1590px\" \/><\/li>\r\n\t<li><strong>Expansions and recessions:<\/strong> We will use the risk parity allocation strategy that the USA created in 1993 to illustrate expansions and recessions. The beginning and end of the recession are observed in hindsight.<br \/>\r\n<img loading=\"lazy\" decoding=\"async\" class=\"aligncenter size-full wp-image-26672\" src=\"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies.jpg\" alt=\"Sharpe Ratio in Different Economies\" width=\"1590\" height=\"1399\" srcset=\"https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies.jpg 1590w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies-300x264.jpg 300w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies-1024x901.jpg 1024w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies-768x676.jpg 768w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies-1536x1351.jpg 1536w, https:\/\/analystprep.com\/study-notes\/wp-content\/uploads\/2021\/11\/Sharpe-Ratio-in-Different-Economies-400x352.jpg 400w\" sizes=\"auto, (max-width: 1590px) 100vw, 1590px\" \/><\/li>\r\n<\/ol>\r\n<p>These two regimes can examine the risk parity and benchmark portfolio:<\/p>\r\n<ul>\r\n\t<li>The RP strategy is strong in a recession, while the benchmark strategy performs negatively in a recession.<\/li>\r\n\t<li>The BM strategy struggles in low-volatility regimes, while the RP strategy performs well in both high and low volatility.<\/li>\r\n\t<li>The BM and RP strategies have higher standard deviations in a non-recession environment.<\/li>\r\n\t<li>The BM has lower average returns in a recession, which is indicated by excess kurtosis and negative skewness.<\/li>\r\n\t<li>Lastly, the RP strategy also has lower average returns in the recession regime with lower kurtosis and volatility than the BM strategy.<\/li>\r\n<\/ul>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>Mark Jayden conducted a historical scenario analysis to examine the effect of regime changes on his portfolio. He observed that the portfolio had negative skewness and a fat tail to the left in a recession regime. Which of the following is the conclusion that Jayden will most likely make about the his portfolio?<\/p>\r\n<ol style=\"list-style-type: upper-alpha;\">\r\n\t<li>Lower average returns.<\/li>\r\n\t<li>Higher average returns.<\/li>\r\n\t<li>Cannot be determined.<\/li>\r\n<\/ol>\r\n<h3>Solution<\/h3>\r\n<p><strong>The correct answer is A<\/strong>.<\/p>\r\n<p>Excess kurtosis and negative skewness indicate lower average returns in a recession regime.<\/p>\r\n<p><strong>B is incorrect.<\/strong> Low kurtosis and positive skewness indicate a higher average return in a recession regime.<\/p>\r\n<p><strong>C is incorrect.<\/strong> It can be determined that excess kurtosis and negative skewness indicate lower average returns.<\/p>\r\n<\/blockquote>\r\n<p>Reading 42: Backtesting and Simulation<\/p>\r\n<p><em>LOS 42 (e) Evaluate and interpret a historical scenario analysis.<\/em><\/p>\r\n<div style=\"background: #f5f7fb; padding: 24px 18px; border-radius: 12px; text-align: center; margin: 36px 0 18px;\"><a style=\"display: inline-block; background: #1a73e8; color: #ffffff; padding: 10px 24px; border-radius: 40px; font-size: 16px; font-weight: bold; text-decoration: none; margin-bottom: 16px;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Start Free Trial \u2192 <\/a>\r\n<div style=\"font-size: 14px; color: #333333; max-width: 650px; margin: 0 auto; line-height: 1.6;\">Master historical scenario analysis, volatility regimes, and Sharpe ratio interpretation to evaluate portfolio performance across changing market environments.<\/div>\r\n<\/div>","protected":false},"excerpt":{"rendered":"<p>&nbsp; Historical scenario analysis is a form of backtesting that examines the risk and performance of an investment strategy at different structural breaks and structural regimes. The most common types of regime changes are from economic expansion to recessions and&#8230;<\/p>\n","protected":false},"author":5,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,473],"tags":[216,564],"class_list":["post-22826","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-portfolio-management","tag-cfa-level-2","tag-portfolio-management","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.6 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Historical Scenario Analysis | CFA Level II Notes<\/title>\n<meta name=\"description\" content=\"Learn portfolio scenario analysis using historical performance, interpreting results, and matching economic terms to past regimes for downturn modeling.\" \/>\n<meta name=\"robots\" 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