by Rick Nason, PhD, CFA
Partner, RSD Solutions Inc.
How many lives does your company have? Is it 1, 10, 100, 1000, more? The reason I ask is because of some discussions I had lately about the applicability of Monte Carlo Simulation. I am a huge fan of Monte Carlo Simulation. I have blogged about this before, but in terms of decision making there are some very strong attributes to using Monte Carlo – not the least of which is that it forces the management team to actually think deeply and carefully about the drivers of the business (and the associated risk relationships).
The problem is that the output from a Monte Carlo is often used without realizing that the probabilities only apply IF the company has a very large number of lives. Only one outcome is going to happen in real life, while Monte Carlo assumes that there are many many lives and outcomes that will be experienced.
The next time you use Monte Carlo (which again I want to emphasize I am a fan of) you need to think carefully about Schrodinger’s Cat puzzle before you implement the decision that you created the Monte Carlo to help with.
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