Decision Making Under Conditions of Uncertainty: A Wakeup Call for the Financial Planning Profession

Hopewell, Lynn
April 2004
Journal of Financial Planning;Apr2004, Vol. 17 Issue 4, p76
Academic Journal
Presents a reprint of the article "Decision Making Under Conditions of Uncertainty: A Wakeup Call for the Financial Planning Profession," by Lynn Hopewell, which originally appeared in the October 1997 issue of "Journal of Financial Planning." The article suggests the use of stochastic models such as Monte Carlo simulation as an effective tool for making financial decisions based on future events. Models that depend on inputs that are influenced by chances are called stochastic. Stochastic models produce many possible answers, described by a distribution. A model that depicts the time of sunset is deterministic because it relies on fixed physical laws. The inputs that affect the weather are uncertain. A model variable that is uncertain is called a random variable. In a deterministic model, one assigns many values. In a stochastic model, a variable is assigned many values. The distribution of variable values often is described by its mean and standard deviation. The Monte Carlo simulation determines the outcome distribution of the forecast variable by exercising the model many times. The Monte Carlo tools discussed in the article provide the means to randomly select values for many variables according to predefined variable distributions and produce statistics and graphs of the forecast variable. INSET: What Is a Monte CArlo Simulation?.


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