Monte Carlo Simulation

goldsim.com/Web/Introduction/MonteCarlo

In general terms, the Monte Carlo method (or Monte Carlo simulation) can be used to
describe any technique that approximates solutions to quantitative problems through
statistical sampling. As used here, 'Monte Carlo simulation' is more specifically used to
describe a method for propagating (translating) uncertainties in model inputs into
uncertainties in model outputs (results). Hence, it is a type of simulation that explicitly and
quantitatively represents uncertainties. Monte Carlo simulation relies on the process of
explicitly representing uncertainties by specifying inputs as probability distributions. If the
inputs describing a system are uncertain, the prediction of future performance is
necessarily uncertain. That is, the result of any analysis based on inputs represented by
probability distributions is itself a probability distribution.

Whereas the result of a single simulation of an uncertain system is a qualified statement ("if
we build the dam, the salmon population could go extinct"), the result of a probabilistic
(Monte Carlo) simulation is a quantified probability ("if we build the dam, there is a 20%
chance that the salmon population will go extinct"). Such a result (in this case, quantifying
the risk of extinction) is typically much more useful to decision-makers who utilize the
simulation results.

In order to compute the probability distribution of predicted performance, it is necessary to

propagate (translate) the input uncertainties into uncertainties in the results. A variety of
methods exist for propagating uncertainty. Monte Carlo simulation is perhaps the most
common technique for propagating the uncertainty in the various aspects of a system to the
predicted performance.

In Monte Carlo simulation, the entire system is simulated a large number (e.g., 1000) of
times. Each simulation is equally likely, referred to as a realization of the system. For each
realization, all of the uncertain parameters are sampled (i.e., a single random value is
selected from the specified distribution describing each parameter). The system is then
simulated through time (given the particular set of input parameters) such that the
performance of the system can be computed. This results is a large number of separate
and independent results, each representing a possible “future” for the system (i.e., one
possible path the system may follow through time). The results of the independent system
realizations are assembled into probability distributions of possible outcomes. As a result,
the outputs are not single values, but probability distributions.

A Simple Example: Rolling Dice

As a simple example of a Monte Carlo simulation, consider calculating the probability of a
particular sum of the throw of two dice (with each die having values one through six). In this
particular case, there are 36 combinations of dice rolls:

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Source: http://hyperphysics.phy-astr.gsu.edu/hbase/math/dice.html

Based on this, you can manually compute the probability of a particular outcome. For
example, there are six different ways that the dice could sum to seven. Hence, the
probability of rolling seven is equal to 6 divided by 36 = 0.167.

Instead of computing the probability in this way, however, we could instead throw the dice a
hundred times and record how many times each outcome occurs. If the dice totaled seven
18 times (out of 100 rolls), we would conclude that the probability of rolling seven is
approximately 0.18 (18%). Obviously, the more times we rolled the dice, the less
approximate our result would be. Better than rolling dice a hundred times, we can easily use
a computer to simulate rolling the dice 10,000 times (or more). Because we know the
probability of a particular outcome for one die (1 in 6 for all six numbers), this is simple. The
output of 10,000 realizations (using GoldSim software):

How Accurate are the Results?

The accuracy of a Monte Carlo simulation is a function of the number of realizations. That
is, the confidence bounds on the results can be readily computed based on the number of
realizations. The two examples below show the 5% and 95% confidence bounds on the
value for each outcome (i.e., there is a 90% chance the the true value lies between the
bounds):

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History of the Monte Carlo Method
Monte Carlo simulation was named after the city in Monaco (famous for its casino) where
games of chance (e.g., roulette) involve repetitive events with known probabilities. Although
there were a number of isolated and undeveloped applications of Monte Carlo simulation
principles at earlier dates, modern application of Monte Carlo methods date from the 1940s
during work on the atomic bomb. Mathematician Stanislaw Ulam is credited with
recognizing how computers could make Monte Carlo simulation of complex systems
feasible:

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 "The first thoughts and attempts I made to practice [the Monte Carlo Method] were suggested
by a question which occurred to me in 1946 as I was convalescing from an illness and playing
solitaires. The question was what are the chances that a Canfield solitaire laid out with 52
cards will come out successfully? After spending a lot of time trying to estimate them by pure
combinatorial calculations, I wondered whether a more practical method than “abstract
thinking” might not be to lay it out say one hundred times and simply observe and count the
number of successful plays. This was already possible to envisage with the beginning of the
new era of fast computers, and I immediately thought of problems of neutron diffusion and
other questions of mathematical physics, and more generally how to change processes
described by certain differential equations into an equivalent form interpretable as a
succession of random operations. Later … [in 1946, I] described the idea to John von
Neumann, and we began to plan actual calculations. " Eckhardt, Roger (1987). Stan Ulam,
John von Neumann, and the Monte Carlo method, Los Alamos Science, Special Issue (15),
131-137

Using GoldSim for Monte Carlo Simulation

GoldSim is a powerful and flexible probabilistic simulation platform for dynamically
simulating nearly any kind of physical, financial, or organizational system. You build a
model in an intuitive manner by literally drawing a picture (an influence diagram) of your
system.

GoldSim is a flexible and easy to use Monte Carlo simulation tool, allowing you to represent
uncertainties and propagating (translating) your uncertainties in model inputs into
uncertainties in model outputs (results). Although GoldSim can be used as a static Monte
Carlo simulator, its real power is that it is also a dynamic simulator,allowing you to
evaluate how systems evolve over time, and predict their future behavior. As such,
GoldSim has powerful features for representing stochastic processes (e.g., rainfall,
demand) and random events (e.g., accidents, failures).

Learn More about GoldSim

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