Chapter 24 - Monte Carlo V2

Question 1

What is the cornerstone in monte carlo?

Answer 1

Risk neutral valuation

Question 2

what is the general idea of monte carlo valuation+

Answer 2

We make use of hte risk neutral valuation principles, and therefore need to find the expected value of some distribution. Instead of using tedious techniques, and soemtimes even impossible ones (due to the function of the claim) we might find it easier to just use simulations instead.

Perform many simulations and average the outcome. Since we use the risk neutral valuation, we then discount the average using the risk free rate.

Question 3

elaborate on the problem of using true probabilities in monte carlo

Answer 3

The thing is that we end up having to change the discount rate for the various paths.