PRIIPs regulation Annex 2 states in Point 20 that bootstrapping is to be used to infer the expected distribution of prices or price levels for the PRIIP’s underlying contracts from the observed distribution of returns.
For a product based on a government bond this approach seems to be inefficient/wrong since there is some knowledge about the way the value of the bond will behave in the future. Namely, it should be expected that the bond will drop to its face (nominal) value. However, if I am correct in understanding what bootstrapping based on historical values will do, this will not be accounted for in the bootstrapping approach?
Especially if the historical data is collected where the value of the bond has been (in average) rising (e.g. mid or early term of a long term bond) or (in average) stable. In this case, bootstrapping will produce an average curve (among others) that is not falling down to the face value. Thus, for government bonds we would see something quite extraordinary at maturity :)
This is quite problematic since all of the quantiles will be overestimated leading to an overestimate in VaR!
Since there is no mention of "domain knowledge" in PRIIPs (Annexes), how would you approach this problem? If you do not find this to be a problem could you please explain why you think so?