12/11/2020 What is Monte Carlo Simulation?

e Carlo Simulation? Definition of Monte Carlo Simulation, Monte Carlo Simulation Meaning - The Economic Times
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Monte Carlo LATEST NEWS Fiscal deficit range rather than a point is need of the hour for India,
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Definition: Monte Carlo Simulation is a mathematical
technique that generates random variables for modelling
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risk or uncertainty of a certain system. Target Price: Rs 5,310-5,320
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Different iterations or simulations are run for generating
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Monte Carlo Simulation is the most tenable method used
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action. Monte Carlo Simulation enables us to see the
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probabilities of outcomes.

Monte Carlo Simulation uses probability distribution for

modelling a stochastic or a random variable. Different
probability distributions are used for modelling input
variables such as normal, lognormal, uniform, and
triangular. From probability distribution of input variable,

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12/11/2020 What is Monte Carlo Simulation? Definition of Monte Carlo Simulation, Monte Carlo Simulation Meaning - The Economic Times

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Compared to deterministic analysis, the Monte Carlo

method provides a superior simulation of risk. It gives an
idea of not only what outcome to expect but also the
probability of occurrence of that outcome. It is also possible
to model correlated input variables.

For instance, Monte Carlo Simulation can be used to

compute the value at risk of a portfolio. This method tries to
predict the worst return expected from a portfolio, given a
certain confidence interval for a specified time period.

Normally, stock prices are believed to follow a Geometric

Brownian motion (GMB), which is a Markov process, which
means a certain state follows a random walk and its future
value is dependent on the current value.

The generalised form of the Geometric Brownian motion is:

?S/S=µ?t+sev?t

The first term in the equation is called drift and the second
is shock. This means the stock price is going to drift by the
expected return. Shock is a product of standard deviation
and random shock. Based on the model, we run a Monte
Carlo Simulation to generate paths of simulated stock
prices. Based on the outcome, we can compute the Value
at Risk (VAR) of the stock. For a portfolio of many assets,
we can generate correlated asset prices using Monte Carlo
Simulation.

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