A sophisticated analytical method which was initially introduced to find solutions for random-behavior problems by calculating approximate probabilities of specific outcomes using simulations based on random variables. In general finance, Monte Carlo is used to calculate the net present value when there is a range or distribution of potential outcomes for each set of assumptions. It is also used to understand the impact of risk and uncertainty in financial models. In option evaluation, Monte Carlo provides a numerical probability approach to the pricing of path-dependent options which cannot be practically decomposed into a series of standard options in an attempt to produce reasonable estimations. This method helps in situations where the underlying return-generating process doesn’t follow a standardized distribution.

Monte Carlo method or simulation is named after the city in Monaco, which is famous for its casinos where world-class gambling and other games of chance are offered. By nature, such games exhibit random behavior, making the prediction of results a time-consuming, exhausting, and in most cases near-to-impossible task.