Monte Carlo simulation
Principles of Finance glossary · Principles Of Finance
Definition
A valuation method based on generating many random paths and averaging payoffs.
Monte Carlo simulation in plain English
When the future is uncertain, sometimes you can't calculate one clean answer, so instead you have the computer 'play the game' thousands of times with different random luck each round, then look at the average result. It's like predicting how a board game usually ends by simulating 10,000 full playthroughs with random dice rolls rather than trying to solve it with a single formula. Each simulated path represents one possible future for the thing you're valuing; averaging all those payoffs gives you an estimate of what it's worth, plus a feel for the range of good and bad outcomes.
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