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Monte Carlo Simulation and Risk Analysis

Monte Carlo Simulation is a statistical technique used to model uncertainty and assess risk across various fields such as finance and engineering by utilizing random sampling and probability distributions. The process involves defining the problem, specifying probability distributions, generating random samples, running simulations, and analyzing results to inform decision-making. Its applications include portfolio risk assessment, reliability analysis, demand forecasting, and cost estimation.

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46 views7 pages

Monte Carlo Simulation and Risk Analysis

Monte Carlo Simulation is a statistical technique used to model uncertainty and assess risk across various fields such as finance and engineering by utilizing random sampling and probability distributions. The process involves defining the problem, specifying probability distributions, generating random samples, running simulations, and analyzing results to inform decision-making. Its applications include portfolio risk assessment, reliability analysis, demand forecasting, and cost estimation.

Uploaded by

kineti7606
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Monte Carlo Simulation

and Risk Analysis


Monte Carlo Simulation
Monte Carlo Simulation is a powerful statistical
technique used to model uncertainty and assess risk
in various fields, including finance, engineering, supply
chain management, and project management. It allows
decision-makers to evaluate potential outcomes and
make informed choices under uncertainty.
Monte Carlo Simulation relies on random sampling and
probability distributions to estimate the likelihood of
different outcomes.
Instead of using single-point estimates, it considers a
range of possible values and runs thousands (or even
millions) of simulations to generate a probability
distribution of outcomes.
Applications of Monte Carlo Simulation

• Finance: Portfolio risk assessment, option pricing,


Value at Risk (VaR)

• Engineering: Reliability analysis, failure risk estimation

• Supply Chain: Demand forecasting, inventory


optimization

• Project Management: Cost estimation, schedule risk


analysis
Key Steps in Monte Carlo Simulation

1.Define the Problem: Identify the uncertain variables and


the objective function.
2.Specify Probability Distributions: Assign probability
distributions to uncertain variables (e.g., normal, uniform,
exponential).
3.Generate Random Samples: Use random sampling
techniques to generate possible values for the uncertain
variables.
4.Run Simulations: Perform thousands of iterations,
calculating the outcome for each set of randomly generated
inputs.
5.Analyze Results: Examine the distribution of outcomes,
calculate key statistics (mean, variance, percentiles), and
assess risk levels.
Scenario: Business Profit Simulation
We will simulate potential profit outcomes based on
uncertain factors:
1.Market demand: Normally distributed (mean =
30,000, std dev = 8,000).
2.Selling price per unit: Uniformly distributed ($20
to $50).
3.Variable cost per unit: Triangular distribution
($10–$25, most likely $15).
4.Fixed costs: $200,000 (fixed and known).
5.Simulations: 5,000 runs.
• (Demand): =NORM.INV(RAND(),$B$2,$B$3)
generates demand using a normal distribution.
• (Price): =RAND()*($B$5-$B$4)+$B$4 generates a
price using a uniform distribution.
• (Variable Cost): Uses an approximation of a triangular
distribution.
•Column E (Revenue): =B2*C2 (Price × Demand).
•Column F (Profit): =E2-(D2*B2)-$B$9 (Revenue -
Variable Cost - Fixed Cost).
Advantages of Monte Carlo Simulation

✅ Provides quantitative risk assessment.

✅ Helps in decision-making under


uncertainty.

✅ Can be applied across various


industries.

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