Monte Carlo Simulation on Portfolio Performance

By

Victor Marcos Hyslop

April 17, 2020

Finance 4315A

CRN: 26486

Executive Summary: For this project, a Monte Carlo simulation is done for the Target Beta portfolio

(retrieved from the past project) in order to form 1,000 possible lifetimes of 35 year-periods for each one.

For each and every single lifetime, different portfolio returns for raises in the market and for generalized

bad times are calculated. Raise scenarios account for reduction on wages and possible gains. On the other

side, bad time scenarios refer to negative events such as a missing payment. For every observation within

the different scenarios, the final portfolio value is calculated. Furthermore, the mean, the median, standard

deviation, maximum value and minimum value are calculated using the data retrieved from the universe

of simulations. The findings of the projects are that the median portfolio return is of $717,918 while the

standard deviation is of $995,930 making the values for the portfolio return to range from $90,418 to

$8,532,523 with an average value of $1,017,524.

Word Count: 155

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1.0 Introduction:

The Monte Carlo simulation method is used as a way to test a model under a set of multiple

different parameters. The Monte Carlo statistical technique is revolutionary in that multiple parameters

can be manipulated in order to test the model and its outcome. For this project, a thousand of different

portfolios are built into 35 lifespan random models. The base portfolio for every lifespan is the Target

Beta portfolio retrieved from Project 4. Each lifespan contains a random set of events which includes

raises and bad times which the base portfolio on that lifespan goes through. The purpose of the project is

to understand the risks and opportunities that the portfolio is subject to by using a Monte Carlo simulation

to generate multiple random scenarios.

Three types of statistical distributions are used to develop the Monte Carlo Simulation. These

distributions are the uniform, the normal and the triangular distributions. A uniform distribution implies

that every lifetime if it has the same value range and the same length, has the same chance to experience a

raise and a bad time. The normal distribution is used to calculate the portfolios’ monthly returns. Also, the

normal distribution is used on several stock market analysis tools as it encompasses the mean, expected

return, standard deviation and the portfolios’ risk. The triangular distribution is used as a subjective

description of a population with a limited sample data set but with a known relationship within variables.

Raises and bad times follow a triangular style distribution with a 1% minimum and a 6% maximum

increase in wages.

2.0 Data and Sample:

2.1 Data:

For this project, the Target Beta portfolio retrieved from the past project is used as the base

portfolio for each lifespan in this project. Each of the lifetimes of this project starts with the final portfolio

value and risk value of the Target Beta portfolio. Each lifetime is individually subject to a different

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random set of parameter values generated with a Monte Carlo simulation in order to assess the portfolio’s

risks and opportunities under certain specific situations. The Excel based tool of Data Analysis is used

with the uniform distribution is also used in the raise’s variables at the beginning but it changes to

triangular distribution at the last years.

2.2 Sample Stocks:

The stock universe to use for the portfolio construction is not exposed to a single risk more than

another. The sample includes an Asian tech company, a retail store in the U.S., regional commercial

banks on opposite borders of the country, and other varied industries serving companies. 1) Innophos

Holdings, ticker symbol IPHS, is a producer of specialty ingredients with applications in food, health,

nutrition, and industrial markets. Its main revenue drivers are consumer and specialty chemical

manufacturers in the U.S., Mexico and Canada. 2) Dime Community Bancshares, Inc, DCOM ticker

symbol, is a regional commercial bank operating in New York. It provides a range of financial services

focusing on development and productive loans through its 29 retail banking offices. 3) Oracle

Corporation, ORCL ticker symbol, is a software development company based in California. Its business

focus is the development of IT business infrastructure. 4)NCR Corporation, NCR, provides software

services for a wide variety of industries ranging from the financial services industries, hospitality and

telecommunications in a worldwide set up. 5) Sierra Bancorp, ticker BSRR, regional retail commercial

bank based in California. Business operations with consumers and businesses, special focus on

agriculture. 6) BlackRock, Inc., BLK symbol. Leader publicly traded investment services company.

Material competitive with its use of alternative investments. 7) Semtech Corporation, ticker symbol

SMTC, semiconductor and advanced algorithms developer for optical data communications and video

transport products. Products used in industrial, medical and communications industries. 8) Asseco

Business Solutions SA, ABS is a Philippines based company. Its main business in providing of media and

entertainment services within Philippines. 9) Comtech Telecommunications Corp. CMTL. U.S. based

company that develops and markets tech solutions for telecommunications infrastructure in the United

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States and Internationally. 10) Crocs, Inc., CROX ticker symbol. Develops, manufactures and retail sales

its product: Sandals and various culture footwear. The company has been shifting from retailing to e-

commerce in the recent years.

3.0 Results:

3.1 Final Values:

In order to calculate the account value for every month-period, monthly returns and monthly

deposits are used. Monthly period deposits are based on every possible raise and every possible bad times

scenarios. Table 1 shows the final values for the Monte Carlo simulation that the Target Beta portfolio is

subject to. On Table 2 the analyst can compare the values for Mean, Median, Minimum Value, Maximum

Value and the Standard Deviation for the Project’s analysis.

Table 1
Final Values for the Set of
Lifetimes on the Monte
Carlo Simulation
Final Values
Mean $1,017,523.72
Median $ 717,917.76
Std $ 995,930.04
Min $ 90,417.94
Max $8,532,522.84
Skew 3.2196
Kurt 14.4154

Statistical values shown in Table 1 show a positive skewed distribution. Having a positive skew

implies that more “good” outcomes are obtained rather than “negative” outcomes. Another statistical

value is the kurtosis value. A normal distribution has a kurtosis of 3. The kurtosis of 14.42 of the Monte

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Carlo analysis distribution reflects an excess kurtosis of 11.42 and a leptokurtic distribution. Having a

leptokurtic distribution implies that much more outliers occur than when compared to a normal

distribution.

3.2 Downside Risk and Probability of Possible Returns:

Downside Risk is the measure of a security’s probability to suffer a decrease in value when the

market condition moves negatively. Downside Risk determines the worst-case scenario for an investment

and indicates the amount the investor may lose. At its 100% level, the downside risk graph (Table 3)

represents the Value at Risk (VaR). Table 3 shows the chances of risk for being under the investment. By

having an investment less than $2,000,000 on dollar value the risk is significantly lower. The risk for over

$2,000,000 dollar investments is materially the same. The analyst can conclude that risk reducing can be

achieved by having a portfolio of maximum $2million as any value above that number is essentially

equally risky.

Table 4 states the probability of different return outcomes of occurring. The Monte Carlo

scenario analysis determines that the most probable outcome with 30% probabilities is of $771,260. The

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Monte Carlo analysis concludes that cumulatively, there are above 90% possibilities that the portfolio

return lie between the ranges of $430,830 and $2,473,160. The Table 4 shows a strong tendency for

diminishing outcome probabilities as the dollar value of it increases.

3.3 Frequency Table

Table 5 stands for the frequency, probability and cumulative probability of the final values of the

simulation. The highest frequency is $771,260 with 29.8% probabilities that account from 298

observations. Furthermore, 87.3% of the cumulative probabilities lie within the $430,880 and the

$1,792,400 values.

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 Table 5
Frequency, Probability and Cummulative Probability
results of the simulatiion
Count Bins Freq Prob Cumulative Prob
0 90,500 1 0.10% 0.10%
1 430,880 241 24.10% 24.20%
2 771,260 298 29.80% 54.00% High 8,600,000
3 1,111,640 181 18.10% 72.10% Low 90,500
4 1,452,020 94 9.40% 81.50% Step 340,380
5 1,792,400 59 5.90% 87.40%
6 2,132,780 34 3.40% 90.80%
7 2,473,160 28 2.80% 93.60%
8 2,813,540 13 1.30% 94.90%
9 3,153,920 12 1.20% 96.10%
10 3,494,300 5 0.50% 96.60%
11 3,834,680 10 1.00% 97.60%
12 4,175,060 5 0.50% 98.10%
13 4,515,440 1 0.10% 98.20%
14 4,855,820 5 0.50% 98.70%
15 5,196,200 1 0.10% 98.80%
16 5,536,580 2 0.20% 99.00%
17 5,876,960 1 0.10% 99.10%
18 6,217,340 2 0.20% 99.30%
19 6,557,720 0 0.00% 99.30%
20 6,898,100 2 0.20% 99.50%
21 7,238,480 0 0.00% 99.50%
22 7,578,860 3 0.30% 99.80%
23 7,919,240 1 0.10% 99.90%
24 8,259,620 0 0.00% 99.90%
25 8,600,000 1 0.10% 100.00%
1000

4.0 Conclusion:

The Monte Carlo simulation analysis demonstrates the value that the portfolio can achieve under

a set of a thousand different parameters. After carefully reviewing the outcomes, mean shows a

$1,017,523 value while the Standard Deviation (used to measure risk) has a $995,930 value, meaning that

the Sharpe ratio is above 1 which is the threshold that I use to determine if the portfolio is worth investing

on it. Because of the characteristics of the distribution, I decide to use the median as the numerator for the

Sharpe Ratio calculation instead of the mean as I consider it more representative. I consider the median

more representative because it takes the number of observations for each value on account. The value of

the Median is of $717,917 which results in a below 1 Sharpe Ratio value. Backing up with the Sharpe

Ratio analysis, I would not recommend investing on this portfolio.

Another key outcome is the statistical distribution values. Distribution of results being leptokurtic

increases risk. Because of the positive skewness, the risk tends to be positive on that the majority of

outliers tend to be “on the right side” meaning that they are positive. A non-risk averse invertor which

would like to engage in a kind of gambling investment situation could invest on this portfolio knowing

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that as the statistical analysis concludes, more than likely the outcome will be an “extreme” outlier. Even

though that outlier could be negative or positive and the statistics show that it would more than likely be

positive, the Sharpe Ratio leads the analyst to conclude that the risk to return proportion in not worth the

risk.

5.0 Appendix:

Table 6; Inputs:

Annual Monthly
Expected
10.64% 16.90% Mean 0.0089 Stdev 0.0488
Return Expected Std

Base Sal 50,000 Invst Rate 5% Monthly Cash 208.33

Year Cash 2,500
Mean Raise 2%
Min Raise -1% Months 420
Max Raise 6%
Max-Mi n 7%
Brk Pnt 0.43 Exp-Min 3%
Max-Exp 7%

Final Values Paid

Mean 1,017,524 109,274
Median 717,918 108,977
Std 995,930 5,465
Min 90,418 96,944
Max 8,532,523 131,889
Skew 3.2196 0.4471349
Kurt 14.4154 0.37693678

Table 7; Monthly Returns

1 2 3 4 5 6 7 8 9 10
-0.04402 0.049223 0.058945 0.082366 0.012699 0.079345 -0.00121 0.036116 0.024299 0.033469
0.103356 0.103405 0.048243 -0.04864 0.022846 0.040564 0.06376 -0.00227 -0.05115 -0.01913
-0.03301 -0.0569 -0.02435 0.071855 -0.05411 0.067082 -0.00939 -0.05161 0.079186 -0.0955
-0.00284 0.006915 0.043358 0.097415 -0.08066 0.078705 -0.08284 0.033337 -0.01358 -0.00236
0.034081 0.027028 0.016145 0.013508 0.092946 0.017981 0.044723 0.013665 -0.03102 0.026349
0.000214 0.069606 0.008607 0.022799 -0.02572 0.032625 -0.0439 0.01518 -0.08217 0.063362
0.023477 -0.03188 0.021108 -0.01737 -0.08228 -0.00531 -0.08522 -0.0144 -0.01431 0.030764
0.091222 -0.04471 -0.02686 -0.01961 0.060024 -0.01413 0.062768 -0.00429 0.049862 0.024111
0.00332 0.077803 0.075362 0.001727 0.049581 -0.07818 0.00938 0.037612 -0.03331 0.095619

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 Table 8; Bad Times

1 2 3 4 5 6 7 8 9 10
0.673757 0.557695 0.681936 0.914029 0.103977 0.273385 0.853511 0.429579 0.507523 0.089206
0.478744 0.211341 0.64388 0.872768 0.854183 0.663045 0.205176 0.48851 0.961638 0.916349
0.966552 0.743553 0.314554 0.297189 0.556566 0.773431 0.787896 0.299753 0.947386 0.407331
0.546709 0.179327 0.857082 0.983306 0.967742 0.90112 0.012513 0.728263 0.577197 0.104007
0.059664 0.376476 0.56151 0.470809 0.237953 0.286752 0.083132 0.384594 0.351238 0.50972
0.155522 0.888577 0.255226 0.812799 0.602588 0.040651 0.219489 0.957152 0.161443 0.077609
0.797937 0.453475 0.838038 0.970153 0.198462 0.693716 0.00473 0.169073 0.420301 0.824
0.893094 0.10651 0.942198 0.831141 0.00531 0.373058 0.858119 0.360363 0.314951 0.566546
0.043611 0.918821 0.717673 0.855922 0.912259 0.603046 0.632527 0.694876 0.185858 0.787622

Table 9; Raises

1 2 3 4 5 6 7 8 9 10
0.392834 0.143559 0.735405 0.698782 0.278878 0.566881 0.801141 0.754357 0.574633 0.630177
0.552355 0.391552 0.362529 0.051729 0.474258 0.346995 0.975249 0.84875 0.961058 0.903653
0.372814 0.045961 0.227577 0.444319 0.915067 0.422742 0.791955 0.551988 0.535661 0.693228
0.102908 0.536607 0.513749 0.909268 0.757225 0.564562 0.225013 0.087466 0.194678 0.611042
0.80633 0.473159 0.989715 0.347392 0.676809 0.607501 0.179388 0.509781 0.465835 0.999786
0.162572 0.242683 0.216712 0.90698 0.733299 0.861385 0.260903 0.396069 0.434034 0.155309
0.892911 0.732505 0.380749 0.487136 0.857936 0.645833 0.17066 0.662496 0.292276 0.674551
0.810877 0.177587 0.749413 0.367199 0.966887 0.950621 0.724693 0.505539 0.51738 0.927854
0.498245 0.133396 0.75396 0.960265 0.699606 0.220618 0.498337 0.468612 0.670705 0.65685

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