Applications in Risk Management

Abstract

This chapter discusses applications of Monte Carlo simulation to risk management. It addresses the problem of measuring the risk in a portfolio of assets, rather than computing the prices of individual securities. Simulation is useful in estimating the profit and loss distribution of a portfolio and thus in computing risk measures that summarize this distribution. We give particular attention to the problem of estimating the probability of large losses, which entails simulation of rare but significant events. We separate the problems of measuring market risk and credit risk because different types of models are used in the two domains.