In finance, we study the trade-off between risk and return. The common definition of risk is uncertainty. For example, when evaluating a potential profitable project, we have to predict many factors in the life of the project, such as the annual sales, price of the final product, prices of raw materials, salary increase of employees, inflation rate, cost of borrowing, cost of new equity, and economic status. For those cases, the Monte Carlo simulation could be used to simulate many possible future outcomes, events, and their various combinations. In this chapter, we focus on the applications of the Monte Carlo simulation to price various options.
In this chapter, we will cover the following topics:
Generating random numbers from standard normal distribution and normal distribution
Generating random numbers from a uniform distribution
A simple application: estimate pi by the Monte Carlo simulation
Generating random numbers from a Poisson distribution...