Monte Carlo Simulation

The Monte Carlo simulation is one of the most used and the most powerful VaR methods, which also include the parametric VaR/CoVaR and the historical simulation. A structured Monte Carlo simulation produces future prices and VaR distributions of single financial positions or portfolios, by applying numerical calculation procedures on a large set of possible scenarios, that are derived from historical series of market variables. The implemented methodology improves the standard Monte Carlo approach, by correcting the standard deviation and the form of the normal distribution through a common post-processing. This affects the calculation results in terms of accuracy and stability, if the simulation is repeated.

The VaR results are very good for non-linear financial instruments, such as options, long-term cash flow assets and pay off of structured products, as they retain the non-linear nature of assets. The Monte Carlo simulation can successfully be applied to Market VaR, Credit VaR and Spread VaR calculation, in various modules of RFW and RE.

For more information, see Market Risk Evaluation Using Monte Carlo Simulation.