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Monte Carlo Simulations: Forecasting Folly?

What happens in Monte Carlo, should stay in Monte Carlo

Nicolas Rabener
10 min read
29 Jan 2024

SUMMARY

  • Financial advisors primarily use Monte Carlo simulations to forecast returns
  • However, this methodology is flawed as it ignores the valuations of asset classes
  • Using capital market assumptions is likely a better approach

INTRODUCTION

The Shanghai Composite Index (SSE) was booming in early 2015, and as it soared, legions of new investors rushed in to try their luck at securities speculation. Although stock bubbles were nothing new, this one had two peculiarities. First, under the regulatory framework, SSE stocks could not rise or fall more than 10% on any given day, which after several months of a bull market, made for some unusual-looking stock price charts. Second, many retail investors focused on buying “cheap” stocks, or those that traded below 20 renminbi (RMB).

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