Question

Discuss the advantages and disadvantages of Monte Carlo analysis in project risk management.

Should Monte Carlo analysis be used in every project? Why or why not?

Answer 1

Advantages=

This can be used for the modeling of non-linear and path-dependent payoff functions which are quite complex in nature

This is less affected by extreme events

Any statistical distribution can be used to simulate the returns

It is quite easy and flexible to use

With the advancement in computing technology, simulation has become quite easy

Disadvantages-

It needs a lot of computing power to perform all the simulation

There are high cost related to the development of VaR

It is not able to simulate the time-dependent variables

In comparison to the molecular analysis, Monte Carlo method is less effective

Monte Carlo method is mainly used to model the probability of different types of outcome which is not easily predictable because of the interference of random variables. So this method can be used in those projects which are likely to be influenced by any probabilistic problem.