What is Monte Carlo Simulation?

Monte Carlo Simulation (also known as the Monte Carlo Method) provides a comprehensive view of what may happen in the future using computerised mathematical techniques that allow people to account for risk in quantitative analysis and decision making.

It tells you not only what could happen, but how likely it is to happen.

We are constantly faced with uncertainty, ambiguity, and variability in life so risk analysis is part of every decision we make. 

Monte Carlo simulations are used to estimate the probability of cost overruns in large projects and the likelihood that an asset price will move in a certain way.

Telecoms use them to assess network performance in different scenarios, helping them to optimize the network.

 

How Do I Use It?

To use Monte Carlo simulation, you must be able to build a quantitative model of your business activity, plan or process. One of the easiest and most popular ways to do this is to create a spreadsheet model using Microsoft Excel. 

Other ways include writing code in a programming language such as Visual Basic, C++, C# or Java or using a special-purpose simulation modeling language.

To deal with uncertainties in your model, you'll replace certain fixed numbers, e.g. in spreadsheet cells, with functions that draw random samples from probability distributions. 

To analyse the results of a simulation run, you'll use statistics such as the mean, standard deviation, and percentiles, as well as charts and graphs. If all this sounds too complicated there are great software tools out there to assist in these tasks.

Whenever you need to make an estimate, forecast or decision where there is significant uncertainty, you'd be well advised to consider Monte Carlo simulation - if you don't, your forecasts could be way off the mark, with adverse consequences for your decisions.

Many business situations involve uncertainty, e.g. variable market demand, unknown plans of competitors, uncertainty in costs, and many others.

If your situation sounds like this, you may find that the Monte Carlo method is surprisingly effective for you.

TRY BLACKCURVE FOR FREE *no credit card required*

You might also like

New Call-to-action