Wednesday, December 18, 2019

Monte Carlo Simulation - 1495 Words

April 2010 ‘The problems of Monte Carlo Simulation’ by David Nawrocki This article describes the problems associated with using the Monte Carlo Simulation Model as a tool for determining future investment outcomes for investors. The tool is widely used by Financial Advisors as a means of showing investors future returns on investments. The article discusses why the use of Monte Carlo Simulation in financial planning is difficult and can lead to incorrect decisions which can have a detrimental impact on investors’ expectations of expected returns. The article tells us that Monte Carlo Simulation uses assumptions based on normal distributions and correlation coefficients of zero, neither of which are real in the financial†¦show more content†¦The results using the Monte Carlo Simulation to model the portfolio were poor. The author shows that although there is reduced risk compared to an all stock portfolio the rewards (returns) are lower. This means a fund manager may move to all stock portfolios. Exploratory Simulation uses historical data and all dependant, all non linear and does not assume normal distribution showed a higher return than Monte Carlo Simulation. The graphs show that using this model the portfolio has a higher return and the standard deviation is lower and timber-stock portfolio has a better risk -return. The article is comparing Monte Carlo Simulation with Exploratory Simulation and the problems associated with Monte Carlo Simulation. It tells us that financial planners have little or no formal training in operations research and they tend to make decisions without understanding the impact of their assumptions on the client. This article was chosen as it appeals to an audience who has an interest in getting the best return for their money with the least possible risk. That audience will include financial planners using software incorporating Monte Carlo Simulation, who want a better understanding of how the use of simulation models can give different forecasts and outcomes when it comes to investing their client’s money. The article shows the problems associated with relying purely on normal distribution and zero correlation without taking intoShow MoreRelatedMonte Carlo Simulation218872 Words   |  876 Pages Preface This is a book about Monte Carlo methods from the perspective of ï ¬ nancial engineering. Monte Carlo simulation has become an essential tool in the pricing of derivative securities and in risk management; these applications have, in turn, stimulated research into new Monte Carlo techniques and renewed interest in some old techniques. This is also a book about ï ¬ nancial engineering from the perspective of Monte Carlo methods. 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