Can someone explain Monte Carlo analysis to me? I am in this section and am trying to comprehend what kind of simulation it does. My notes have the example ‘stocks’ as there are two risk factors: stock price and interest rate. So does this simulation just put together thousands of scenarios with different stock prices and interest rates and than average the results to the expected value of the security? Is there a better example that can help me understand what it is doing and how it outputs the result? Thanks
Future outcomes are always uncertain. Each year constitutes a random throw of the dice (in your case, stock price and interest rates) and the geometric rate of return can vary widely depending on market fluctations. Sometimes, however, a client will have a predetermined withdrawal rate in dollars. In a down market, the withdrawal can severely impact portfolio performance. Monte Carlo analysis attempts to capture the terminal value of a portfolio under thousands of different outcomes.