POWELL
KENNETH R. BAKER
MANAGEMENT
SCIENCE
CHAPTER 14
MONTE CARLO
SIMULATION
POWERPOINT
INTRODUCTION
Monte Carlo simulation is an important and
flexible technique for modeling situations in which
uncertainty is a key factor.
Analytic Solver Platform provides the capability to
implement Monte Carlo simulation in spreadsheet
models.
Simulation can describe not only what the
outcomes of a given decision could be, but also the
probabilities with which these outcomes will occur.
In fact, the result of a simulation is the entire
probability distribution of outcomes.
In a sense, simulation is an advanced form of
sensitivity analysis in which we attach a probability
to each possible outcome.
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INTRODUCTION
We often wish to determine the probability of a particular
set of outcomes.
Such tail probabilities are often suitable measures of
the risk associated with a decision.
While decision trees provide a simple means for analyzing
decisions with uncertainty and risk, simulation is the tool
of choice when there are a large number of uncertainties,
especially when these are represented by continuous
distributions.
Simulation is also a practical method when the underlying
model is complex.
However, it is important to realize that, just as with
decision trees, the result of a simulation is a probability
distribution for each outcome.
Analyzing these distributions and extracting managerial
insights is an important part of the art of simulation.
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SENSITIVITY ANALYSIS
The base-case model should be thoroughly
explored, using parametric sensitivity,
tornado charts or other methods, before
undertaking a simulation analysis.
We can think of simulation as a sophisticated
approach to sensitivity analysis.
Whereas sensitivity analysis is a necessary
first step, and can often reveal unexpected
relationships in the model, a simulation
analysis is required to analyze the combined
effects of changes in many inputs.
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SPECIFYING OUTPUTS
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3.
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2.
Frequency
Cumulative Frequency
Reverse Cumulative Frequency
Sensitivity
Scatter Plots
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SIMULATION SENSITIVITY
To answer sensitivity questions with a simulation
model, we need to run a simulation in Analytic
Solver Platform once for each value of the
parameter we wish to test. This is done in two
steps.
First we define the range of values for the input
parameter using a PsiSimParam function, akin to
the PsiSenParam function for deterministic
sensitivity analysis.
Then we create a table (Report) or chart of values
for specific statistics of an output cell by running
simulations for each value of the input.
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A BERNOULLI DISTRIBUTION
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A BINOMIAL DISTRIBUTION
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A UNIFORM DISTRIBUTION
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A TRIANGULAR DISTRIBUTION
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A NORMAL DISTRIBUTION
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Analytic Solver
PlatformToolsFit.
This sequence brings up the Fit
Options window in which we
specify the location of the data
and choose to fit continuous
distributions to the data.
Press the Fit button, and
Analytic Solver Platform fits
each of the continuous
distributions in turn to this data
set and presents them in order
of goodness-of-fit.
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AN EXPERIMENTAL METHOD
The simplest approach to determining the
precision of a simulation estimate is to
experiment with multiple independent runs.
We must ensure that different random
numbers are used each time we run a
simulation.
In Analytic Solver Platform, we select Analytic
Solver PlatformOptionsAll Options, select
the Simulation tab, and enter 0 in the Sim.
Random Seed field. Now we pick an initial
sample size.
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SIMULATION RESULTS
When we double click on an output cell after
running a simulation, the Simulation Results
window opens.
We can show the mean value for the simulation
outcomes by selecting Markers in the task
pane. We then click on the double-plus icon,
select Mean under Type, and enter Mean in the
Description window.
We can calculate and display a tail probability
by entering a lower or upper cut-off value
under Statistics Chart Statistics.
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SUMMARY
Simulation shows us how uncertainty in the inputs influences
the outputs of our analysis.
Like optimization, simulation can be seen as a sophisticated
form of sensitivity analysis.
In Excel, simulation can be carried out conveniently using
Analytic Solver Platform, which provides all the probability
models needed to express the uncertainties in our
assumptions, and automates the repetitive process of
sampling from these distributions. Finally, it provides
extensive methods for displaying and analyzing the results.
Simulation is a powerful tool when used appropriately, but it
should never be used before an appropriate sensitivity
analysis is carried out on a deterministic version of the model.
What-if analysis, involving use of Data Sensitivity and Tornado
Charts, uncovers those input parameters that have the
biggest impact on the outcomes.
These should be the focus of any uncertainty analysis.
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SUMMARY
Every simulation analysis involves four major
activities:
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