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Understanding Monte Carlo simulation

monte carlo simulation, also known as probability simulation is a technique with the help of which the impact of risk and uncertainty in various financial, project management and other forecasting models. It is a rational method usually used when a model has uncertain parameters. It simply shows how inputs in system can impact outcome. It is a feasible method for modelling risk in a system. Wide variety of fields such as physical science, computational biology, statistics, artificial intelligence, and quantitative finance use this method broadly. It, however, provides a probabilistic estimate of the uncertainty in a model. <br>During world war 2 Monte Carlo Simulation Technique was introduced.<br>

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Understanding Monte Carlo simulation

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  1. Understanding Monte Carlo simulation

  2. montecarlo simulation, also known as probability simulation is a technique with the help of which the impact of risk and uncertainty in various financial, project management and other forecasting models. It is a rational method usually used when a model has uncertain parameters. It simply shows how inputs in system can impact outcome. It is a feasible method for modelling risk in a system. Wide variety of fields such as physical science, computational biology, statistics, artificial intelligence, and quantitative finance use this method broadly. It, however, provides a probabilistic estimate of the uncertainty in a model. • During world war 2 Monte Carlo Simulation Technique was introduced.

  3. Why to use • At times when any estimation, forecast or decision where the uncertainty lies, Monte Carlo simulation can help. Businesses where uncertainty is involved like variable market demand, uncertainty in costs uses this. For valuing risk of portfolio, Monte Carlo simulation can be used. • How does it work • First, a risk analysis is performed by building models of possible results by substituting a range of values. After this, using a different set of values every time it calculates results again and again. The number of calculations before it completely depends on the amount of uncertainty. A probability distribution is used so that variables can have a different probability of different outcomes. A probability distribution is considered a much realistic way of risk analysis.

  4. What are its benefits • It provides projects decision-maker with possible results and probabilities of each outcome. It gives various advantages such as: • Probabilistic Results- in this it shows both what could happen and the likeliness of each outcome • Graphical Results- graphs of each outcome can be effortlessly created from the data generated by Monte Carlo simulation • Sensitivity Analysis- it makes it much easier to see the effect on bottom-line results of each input • 4. Scenario Analysis- analysts find it much easier to make out which value does each input hold when a particular outcome occurs

  5. What knowledge is required to use it • One must possess knowledge of how a quantitative model of business activity, plan and process can be built. The easiest way to do this is by using Microsoft Excel and creating a spreadsheet there, Frontline Systems' Risk Solver can be used as a simulation tool. • Another way out can be writing code in a programming language such as C++ or java. Some basics of probability and statistics should be known. Now to analyse the results of a simulation take help of statistics such as the mean, standard deviation, charts and graphs. Also, various software and tools are available in the market backed up with technical support and assistance to help you.

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