Allan Roth, who writes a blog for CBS Money Watch called "The Irrational Investor,"
recently asked his readers a rhetorical question: Is Financial Monte Carlo Simulation Dead? Since rhetorical questions demand an answer in less time than it takes the questioner to draw breath, Roth obliged.
While expressing sympathy for the investors who were victims of poor risk assessment and forecasting when the financial markets shook themselves down to rubble in 2008, Roth is taking a very politely defensive swing at one of the many critics of risk analysis who have turned up the volume since then–one Jim Otar of Otar Retirement Solutions
and the author of Unveiling the Retirement Myth
Roth is an experienced user of Monte Carlo software who knows the pitfalls of overoptimistic assumptions. He says he finds 99 percent of the Monte Carlo models he’s see over the years to be inadequate because of this flaw. Jim Otar, for his part, finds other flaws as well: in the generation of randomness and trends and in the sequence of returns. Otar’s modeling method does not rely on randomness but on a century’s worth of historical data.
Our two worthy opponents put their models up against one another in a match that crunched identical inputs. Their models produced very, very similar results, apparently satisfying each analyst as to the superiority of his method. But while Roth said nice things about Otar and his model, he pointed out the limitations of relying on historical information alone. In other words, he doesn’t concede.
For any kind of retirement planning models, he says, the cure to flaws is conservative input. Then he giddily sends his readers to one of those rudimentary online Monte Carlo calculators that investment firms love to offer their clients.
Rumors of this death are greatly exaggerated.