Save 30% on all 2023 Study Packages with Code: BLACKFRIDAY30. Valid until Nov. 28th.

# Monte Carlo Simulation vs. Historical Simulation

Monte Carlo simulation and historical simulation are both methods that can be used to determine the riskiness of a financial project. However, each method uses different assumptions and techniques to develop the probability distribution of possible outcomes.

## Historical Simulation

Historical simulation involves the use of a historical record of returns or random variables to simulate the possible outcomes. The method assumes that past performance is an indication of future performance. Historical simulation uses actual past figures or variables that have been experienced before. Each simulation involves factoring in a specific value of a random variable and calculating the value of the project or asset.

## Monte Carlo Simulation

In contrast, Monte Carlo simulation relies on modeling the distribution of risk factors using a random number generator. It involves the creation of a computer-based model that incorporates all the random variables that may affect the performance of a financial project, including any interrelationships, interdependencies, and serial correlations between them. The model is run hundreds or thousands of times to provide output that can be recorded and ordered to estimate the probability distribution of the possible outcomes.

Monte Carlo simulation comes with the advantage of incorporating a wider variety of scenarios than historical data, whose information scope is limited. In addition, Monte Carlo simulation answers the “what if” question, which is not possible under historical simulation. For example, it is possible to increase a specific variable by, say, 20%. One can then determine the overall effect of such an action on the model. However, it is more expensive relative to historical data and may require the acquisition of the services of an expert.

Historical simulation uses the actual distribution of risk factors. This means that the estimation of the actual distribution of changes in the risk factors is not required. However, past performance or changes may not be indicative of future performance. In addition, “outliers” or the events that occur infrequently may not be incorporated in the simulation. Similarly, variables or risks not occurring within the time period chosen for simulation purposes are likely to be left out.

Shop CFA® Exam Prep

Offered by AnalystPrep

Featured Shop FRM® Exam Prep Learn with Us

Subscribe to our newsletter and keep up with the latest and greatest tips for success
Shop Actuarial Exams Prep Shop GMAT® Exam Prep

Sergio Torrico
2021-07-23
Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
diana
2021-07-17
So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
Kriti Dhawan
2021-07-16
A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
nikhil kumar
2021-06-28
Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
Marwan
2021-06-22
Great support throughout the course by the team, did not feel neglected
Benjamin anonymous
2021-05-10
I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
Daniel Glyn
2021-03-24
I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
michael walshe
2021-03-18
Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.