A simulation that attempts to simulate the future using an uncertain variable. For example, to simulate the future stock price, a simulation may use an algorithm using the current price, mean/average of the stock and volatility/standard deviation. The simulation will randomly generate a term that will change the volatility resulting in a single simulated future price. However, the Monte Carlo method refers to the simulation being run hundreds if not thousands of times with each simulation referred to as a path. In this simplistic example, the future price is determined by taking the average of all of the prices. Customary way to value MBS and other securities with embedded options. Monte Carlo simulations generate numerous random interest rate paths, present valuing the cash flows of the security under each path while taking the option into account, to derive the value of the security.
