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(1) In option evaluation, a numerical probability approach to the valuation of path-dependent options which cannot be decomposed easily into a series of standard options with closed-form (analytic) solutions. The Monte Carlo technique is also used when there is reason to believe that the underlying return-generating process does not match a standardized distribution. In applying the Monte Carlo method, an analyst will generate a series of prices for the underlying(s) using a model that approximates the market's price-generating process. An average (expected) option value at expiration for each underlying or set of underlyings is determined and discounted to a present value. The quality of the result depends on the realism of the price- or return-generating process. (2) A sampling technique used to fix and evaluate cases in risk management stress testing. (3) A procedure for simulating the probable distribution of a strategy's return by repeatedly sampling from a population with a presumed distribution.
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