Monte Carlo Simulation in Financial Valuation

Abstract

This paper uses Monte Carlo simulation of a simple equity growth model with resampling of historical financial data to estimate the probability distribution of the future equity, earnings and payouts of companies, which are then used to estimate the probability distribution of the future return on the stock and stock options. The model is used on the S&P 500 stock market index and the Coca-Cola company. The relation between USA government bonds, the S&P 500 index and the Dow Jones Venture Capital index (DJVC) is also studied and it is found that there is no consistent and predictable risk premium between USA government bonds and the S&P 500 and DJVC indices, but there is significant correlation between the monthly returns of the S&P 500 and DJVC indices.

Keywords: Monte Carlo Simulation, Jensen's Inequality, Equity Risk Premium