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Monte Carlo Simulation

Monte Carlo simulation is a technique used to approximate probability distributions of potential outcomes by conducting multiple trial runs or simulations using random variables. It is used across many fields to model risk and uncertainty. The key aspects are running many simulations that sample from input probability distributions, tracking the performance in each simulation, and compiling the results to develop distributions of possible outcomes. The technique gets its name from the city of Monte Carlo and was first used by scientists working on the atom bomb.

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29 views12 pages

Monte Carlo Simulation

Monte Carlo simulation is a technique used to approximate probability distributions of potential outcomes by conducting multiple trial runs or simulations using random variables. It is used across many fields to model risk and uncertainty. The key aspects are running many simulations that sample from input probability distributions, tracking the performance in each simulation, and compiling the results to develop distributions of possible outcomes. The technique gets its name from the city of Monte Carlo and was first used by scientists working on the atom bomb.

Uploaded by

Rama Rajesh
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

• A problem solving technique used to approximate


the probability of certain outcomes by running
multiple trial runs, called simulations, using random
variables.
• The technique is used by professionals in widely
disparate fields such as
• Finance
• Project management
• Energy, manufacturing
• Engineering
• Research and development
• Insurance
• oil & gas and the environment.
• HISTORY
• Monte Carlo simulation was named after the
city in Monaco.
• The technique was first used by scientists
working on the atom bomb.
HOW MCS WORKS
• In Monte Carlo simulation, the entire system is simulated a large number
(e.g., 1000) of times.
• Each simulation is equally likely, referred to as a realization of the system.
• For each realization, all of the uncertain parameters are sampled (i.e., a
single random value is selected from the specified distribution describing
each parameter).
• The system is then simulated through time such that the performance of
the system can be computed.
• This results is a large number of separate and independent results, each
representing a possible “future” for the system.
• The results of the independent system realizations are assembled into
probability distributions of possible outcomes. As a result, the outputs
are probability distributions.
EXAMPLE: ROLLING DICE
• As a simple example of a Monte Carlo simulation,
consider calculating the probability of a particular
sum of the throw of two dice (with each die having
values one through six).
• In this particular case, there are 36 combinations of
dice rolls:
• Based on this, We can manually compute the
probability of a particular outcome. For example, there
are six different ways that the dice could sum to seven.
Hence, the probability of rolling seven is equal to 6
divided by 36 = 0.167.
• Without computer, we could throw the dice a hundred
times and record how many times each outcome
occurs. If the dice totaled seven 18 times (out of 100
rolls), we would conclude that the probability of rolling
seven is approximately 0.18 (18%).
• But Better than rolling dice a hundred times,
we can easily use a computer to simulate
rolling the dice 10,000 times (or more).
Because we know the probability of a
particular outcome for one die. The output of
10,000 realizations:
• HOW THE RESULTS ARE ACCURATE
• The accuracy of a Monte Carlo simulation is a
function of the number of realizations.
• ADVANTAGES
• Probabilistic Results:
– Results show not only what could happen, but how
likely each outcome is.
• Graphical Results:
– In Monte Carlo simulation , it’s easy to create graphs of
different outcomes and their chances of occurrence.
• Sensitivity Analysis:
– In Monte Carlo simulation, it’s easy to see which inputs
had the biggest effect on results.

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