Monte Carlo Simulation

Monte Carlo Simulation is a method to understand the impact of risk on the return by generating many price scenarios (usually thousands) to value the assets in a portfolio over a range of possible market conditions. In general, different iterations or simulations are run for generating paths, and the outcome is arrived at by using suitable numerical computations. It is useful in defining a range of estimates within which the outcome can lie.

Monte Carlo simulation tends to follow four simple steps:

1.Identify a mathematical model of the activity process you want to explore.

2.Define the parameters (like mean and standard deviation) for each factor in your model.

3.Create random data according to those parameters.

4.Simulate and analyze the output of your process.