Financial Toolbox™ enables you to model dependent financial and economic variables, such as interest rates and equity prices, by performing Monte Carlo simulation of stochastic differential equations (SDEs). The flexible architecture of the SDE engine provides efficient simulation methods that allow you to create new simulation and derivative pricing methods.
The following table lists tasks you can perform using the SDE functionality.
|To perform this task ...||Use these types of models ...|
|Simulating Equity Prices|
|Simulating Interest Rates|
|Pricing Equity Options|
|Stratified Sampling||All supported models|
|Performance Considerations||All supported models|
Monte Carlo simulation literature often uses different terminology for the evolution of the simulated variables of interest, such as trials and paths. The following sections use the terms trial and path interchangeably.
However, there are situations where you should distinguish between these terms. Specifically, the term trial often implies the result of an independent random experiment (for example, the evolution of the price of a single stock or portfolio of stocks). Such an experiment computes the average or expected value of a variable of interest (for example, the price of a derivative security) and its associated confidence interval.
By contrast, the term path implies the result of a random experiment that is different or unique from other results, but that may or may not be independent.
The distinction between these terms is unimportant. It may, however, be useful when applied to variance reduction techniques that attempt to increase the efficiency of Monte Carlo simulation by inducing dependence across sample paths. A classic example involves pairwise dependence induced by antithetic sampling, and applies to more sophisticated variance reduction techniques, such as stratified sampling which is a variance reduction technique that constrains a proportion of sample paths to specific subsets (or strata) of the sample space.
SDE functions in the Financial
Toolbox software use the parameters
NSteps as follows:
The input argument
NTrials specifies the number of
simulated trials or sample paths to generate. This argument always
determines the size of the third dimension (the number of pages) of the
output three-dimensional time series array
Indeed, in a traditional Monte Carlo simulation of one or more
variables, each sample path is independent and represents an independent
NSteps represent the number of simulation periods
and time steps, respectively. Both periods and time steps are related to
time increments that determine the exact sequence of observed sample
times. The distinction between these terms applies only to issues of
accuracy and memory management. For more information, see Optimizing Accuracy: About Solution Precision and Error
and Managing Memory.