What is 'Stochastic Modeling'
A method of financial modeling in which one or more variables within the model are random. Stochastic modeling is for the purpose of estimating the probability of outcomes within a forecast to predict what conditions might be like under different situations. The random variables are usually constrained by historical data, such as past market returns.
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BREAKING DOWN 'Stochastic Modeling'
The Monte Carlo Simulation is an example of a stochastic model used in finance. When used in portfolio evaluation, multiple simulations of the performance of the portfolio are done based on the probability distributions of the individual stock returns. A statistical analysis of the results can then help determine the probability that the portfolio will provide the desired performance.
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