Risk glossary

 

Monte Carlo simulation

A method of pricing derivatives by simulating the evolution of the underlying variable (or variables) many times over. The average outcome of the simulation is an approximation of the derivative’s value. Monte Carlo is useful in the valuation of complex derivatives for which exact analytical solutions have not been found, but it can be very computationally intensive. Monte Carlo simulation can also be applied to a portfolio of instruments, rather than a single instrument, to estimate the value-at-risk (VaR) of that portfolio.

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