1 Monte-Carlo Simulation Simulation with Spreadsheets

2 Monte-Carlo Simulation A method for explicitly modeling uncertainty in a decision support model such as the spreadsheets we’ve built Descriptive – estimate probability distribution of key model outputs –Goes beyond expected values and point estimates Quasi-static model – often doesn’t really capture detailed flow of events over time –Discrete event simulation used for this – we’ll do later Often called Risk Analysis –widely used in financial services and Crystal Ball –products that facilitate Monte-Carlo simulation from within spreadsheets Facilitates comparing multiple scenarios over multiple performance measures –it’s really a way of running controlled experiments –like most experiments, output must be analyzed statistically

Why Important to Model Uncertainty? The world is uncertain Replacing random quantities with averages or single “guesstimates” can be dangerous –The Flaw of Averages Allows prediction of distribution of results –Not just one predicted number or outcome Sensitivity analysis of outputs to inputs –Which inputs really affect the outputs?

4 Useful Documents Distributions, Simulation, and Excel FunctionsDistributions, Simulation, and Excel Functions –This is the “Distributions, Simulation, and Excel Functions” document created by Prof. D. Doane. I’ve posted it on the web in Session 5. –We’ll do this in class today

5 is a widely used Excel add-in that facilitates creation and analysis of spreadsheet based simulation models Contains many probability distributions for modeling random inputs Includes tool (BestFit) for fitting input distributions Automates bookkeeping for running many simulation replications and creates a ton of tabular and graphical output reports

Building a Spreadsheet Based Simulation Model (1) Build deterministic model InputsOutputs Formulas (2) Choose inputs to model as random Inputs Stochastic or Uncertain or Random Inputs Deterministic Inputs (3) Model uncertain inputs with probability distributions Uniform NormalPoissonExponentialEmpirical Many more…

See “Distributions, Simulation and Excel Functions” handout that Doane created.

Building a Spreadsheet Based Simulation Model (4) Recalculate spreadsheet many times 2 options (4.2) Use spreadsheet simulation add-in such or Crystal Ball (4.1) “Manually”, through formulas and either many rows or VBA “Running the – Crystal Ball – mwww.decisioneering.co m Each recalculation of the spreadsheet is a “simulation run” or the result of an experiment Like standard experiments, results must be analyzed using statistics

Examples JCHP – Break Even –Let’s add some uncertainty to this model Demand Costs JCHP-BreakEven-Simulation-01.xls Portable Monitoring Devices –We’ll look at this later this session or next session

(5) Analyze outputs Probability distribution of output variable, NOT just expected value. Demand = RiskNormal(2609,200) Demand = RiskNormal(2870,200) JCHP-Simulation-01.xls

Output Histogram Graph and Table are linked Sliders Stats

The Bigger Picture Create several or many scenarios to simulation –Input variable values (including parameters for probability distributions –Perhaps model structure itself Analyze performance measures for each scenario Synthesize results –Pick “best” system or “best k out of n” systems –Interpret results and “make decision” –Simulation results just add another dimension to the discussion regarding the decision –Embed in optimization framework to formally compare many scenarios with respect to some objective function

Some Advantages Much cheaper to experiment with simulation model than real system Provides nice analytical framework for comparing multiple scenarios when uncertainty in key inputs is significant Get a prediction of the distribution of the output variables we are interested in Often models can be reused Simulation models usually require fewer simplifying assumptions than analytical models are are often easier to use –We’ll explore queueing models soon and this will be clearer Simulation may provide only available approach to analyzing complex systems

Some Disadvantages Development may be time consuming Data may be difficult or impossible to obtain Decision makers may not understand the technique nor be able to properly interpret the results Dazzle of the technique can mask flaws in design and/or input data Simple analytical models might be overlooked Run times may be “long” You, as the decision maker, must use your brain to come up with the scenarios to be simulated