Applying the Monte Carlo simulation

Monte Carlo simulation is used to study the response of a model that’s used randomly generated inputs. The simulation process takes place in the following three phases:

1. N inputs are generated randomly.
2. A simulation is performed for each of the N inputs.
3. The outputs of the simulations are aggregated and examined. The most common measures include estimating the average value of a certain output and distributing the output values, as well as the minimum or maximum output value.

Monte Carlo simulation is widely used for analyzing financial, physical, and mathematical models.

Generating probability distributions

Generating probability distributions that cannot be found with analytical methods can easily be addressed with Monte Carlo methods. For example, let’s say we want to estimate the probability distribution of the damage caused by earthquakes in a year in Japan.

Important note

In this type of analysis...