Why Monte Carlo? Monte Carlo simulation is the Swiss Army knife of quantitative finance....
Why Monte Carlo?
Monte Carlo simulation is the Swiss Army knife of quantitative finance. When analytical solutions don't exist, we simulate: generate thousands of possible future price paths, price the derivative on each path, then average and discount.
The method is named after the Monaco casino — a nod to randomness. But there's nothing gambling about it when done correctly.
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The geometric Brownian motion (GBM) model is the starting point:
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