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Monte Carlo My Presentation PDF

The document discusses Monte Carlo simulation. It defines simulation as imitating real-world processes over time using computers. Monte Carlo simulation specifically uses random numbers and probability to simulate outcomes of complex systems. It was developed during WWII to study war strategies probabilistically. Monte Carlo simulation can be used in domains like finance, economics, and risk management to evaluate portfolio sensitivities and risk measures. The document provides an example of a basic Monte Carlo experiment to establish that the least squares estimator is unbiased.

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341 views11 pages

Monte Carlo My Presentation PDF

The document discusses Monte Carlo simulation. It defines simulation as imitating real-world processes over time using computers. Monte Carlo simulation specifically uses random numbers and probability to simulate outcomes of complex systems. It was developed during WWII to study war strategies probabilistically. Monte Carlo simulation can be used in domains like finance, economics, and risk management to evaluate portfolio sensitivities and risk measures. The document provides an example of a basic Monte Carlo experiment to establish that the least squares estimator is unbiased.

Uploaded by

RASHMI
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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301: Financial Econometrics & Equity

Research

Unit VI
Monte Carlo Simulation
By: Utkarsh Gupta
4115009009

What is simulation?

Simulation is the imitation of the operation of real world

process or system over time.

Simulation is useful when the mode is computed and the

analytic methods are difficult to apply.

Use

of

computer

simulation

techniques

helps

in

construction of large, complex models that are closer to


reality.

What is Monte Carlo Simulation

The technique of probabilistic model, also know as Monte


Carlo Technique.

It is a numerical method for statistical simulation which


utilizes sequences of random numbers to perform the
simulation.

Monte Carlo Technique was developed by a mathematician


known as Monte Carlo during the Second World War who

tried to study various strategies of war with related probabilities


and the risk involved and choose one of them with minimum
risk.

This techniques can be used in different domain

Complex Integral Computation

Economics Specially in Risk Management

Extensively used in financial institutional.

To evaluate sensitivities of portfolio to various parameters

and to compute risk measurements.

Random Numbers in Monte Carlo


Simulation

Uniformly distributed numbers in (0,1)

Most useful method for obtaining random numbers for

computer use is a pseudo random number generator.

History

1930s : Enrico Fermi uses Monte Carlo in the calculation of


neutron diffusion.

1940s: Stan Ulam while playing solidate tries to calculate the


likehood of winning based on the initial layout of the cards.

He triea many different layout and observing the number of


successful games.

A Simulation model

Decision and
uncontrollable
variables

Measures of
Simulation

performance or

model

behavior of the

system

Monte Carlo experiment

To introduce the basic idea, consider two variable :


Yi =1 + 2Xi + ui

A Monte Carlo experiment proceeds as follows:

Step 1: Suppose the true values of the parameters are as follows :


1 = 20 & 2 = 0.06
Step 2 : Choose the sample size, say n = 25
Step 3 : Now, fix the value of X for each observation. In all you will have
25 X values.

Step 4 : Suppose you go to a random number table, choose 25


values, and call them ui (these days most statistical

packages have built-in random number generators)


Step 5 : Since you know 1, 2, Xi and ui using (3.8.1) you obtain

25 Yi values.
Step 6 : Now using the 25 Yi thus generated, you regress these

on the 25 X values chosen in step 3, obtaining


,the least-square estimators.

Step 7 : Suppose you repeat this experiment 99 times, each time using
the same 1, 2 and X values. Of course, the ui values will
vary from experiment to experiment.
Therefore, in all you have 100 experiments, thus generating
100 values each of 1 and 2. (In practice, many such

experiments are conducted, sometimes 1000 to 2000.)


Step 8 : You take the average of these 100 estimates and call them

Step 9 : If these average values are about the same as the true values
of 1 and 2 assumed in step 1, this Monte Carlo experiment
established that the
indeed unbiased.

least-square estimators are

These steps characterize the general nature of the Monte Carlo


experiments.

Such experiments are often used to study the statistical


properties of various methods of estimating population
parameters.

They are particularly useful of study the behavior of estimators in


small, or finite, samples.

These experiments are also an excellent means of driving the


concept of repeated sampling that is basis of most of classical

statistical inferences.

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