# Monte Carlo method

From ACT Wiki

## Monte Carlo methods in VaR analysis

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).

Monte Carlo simulations consist of two steps:

- First, a stochastic (random) process for financial variables is specified as well as process parameters.

- Both historical data and appropriate judgement can be used for such parameters as risk and correlations.

- 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.

- A distribution of returns is eventually produced, from which a VaR figure can be measured.

## Monte Carlo methods in other applications

More generally, Monte Carlo methods are the simulation of multiple fictitious outcomes, using a combination of historical and judgemental parameters and a randomised process.

The name originated from the famous Monte Carlo casino.