imported>Doug Williamson |
imported>Doug Williamson |
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| | ''Borrowings management'' |
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| == Monte Carlo methods in VaR analysis ==
| | To pay down debt means repaying the principal, in full or in part. |
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| In Value at Risk analysis, an alternative method for calculating the probability distribution (rather than using the Delta-normal method or the Historical simulation method).
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| Monte Carlo simulations consist of two steps:
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| :First, a stochastic (random) process for financial variables is specified as well as process parameters.
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| :Both historical data and appropriate judgement can be used for such parameters as risk and correlations.
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| :Second, multiple fictitious price paths are simulated for all variables of interest. At each horizon considered, the portfolio is marked-to-market using full valuation.
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| :A distribution of returns is eventually produced, from which a VaR figure can be measured.
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| Comparing the methods:
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| :1. The Delta-normal method is the simplest method to implement.
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| :The main drawbacks are the assumption that risk factors have normal distributions, and the assumption that the assets are linear (in other words, that they do not contain options).
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| :2. The Historical simulation method is also relatively simple to implement.
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| :The main drawback is that the historical information used may not adequately represent future probability distributions. (This is also a drawback of the delta-normal method.)
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| Monte Carlo techniques are designed to address these shortcomings.
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| Disadvantages of Monte Carlo methods include their relative complexity.
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| == Monte Carlo methods in other applications ==
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| More generally, Monte Carlo methods are the simulation of multiple fictitious outcomes, using a combination of historical and judgemental parameters and a randomised process.
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| The name originated from the famous Monte Carlo casino.
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| == See also == | | == See also == |
| * [[Delta-normal method]] | | * [[Debt]] |
| * [[Historical simulation method]] | | * [[Pay]] |
| * [[Stochastic]] | | * [[Principal]] |
| * [[Value at risk]]
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| [[Category:Risk_frameworks]]
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