Unit 5:

Random Numbers,
Distributions and Basic
Simulation Setup
Prof. Hemendra Gupta
What is a random number?

• As the term suggests, a random number is a number chosen by

chance -- i.e., randomly, from a set of numbers. All the numbers
in a specified distribution have equal probability of being chosen
randomly.
• A random number occurs in a specified distribution only when
two conditions are met: The values are uniformly distributed
over a defined interval or set, and it is impossible to predict
future values based on past or present ones.
Wiener process?

• Wiener process, also called Brownian motion, is a kind of

Markov stochastic process.
• Stochastic process: whose value changes over time in an
uncertain way, and thus we only know the distribution of the
possible values of the process at any time point.
• RANDBETWEEN function would give you the random numbers,
but there is a high possibility of repeats in the result.
• RAND function is more likely to give you a result without
repetitions. However, it only gives random numbers between 0
and 1.
• While simple random walk is a discrete-space (integers)
and discrete-time model, Brownian Motion is a continuous-
space and continuous-time model, which can be well
motivated by simple random walk.
Uniform Distribution
• In a uniform distribution, there is equal likelihood anywhere
between the minimum and a maximum. A uniform
distribution looks like a rectangle.
 Normal Distribution
• Normal, or Gaussian, distribution describes a pattern where
values in your defined range occur more frequently around a
center point, or mean. Using the sales projection example, you
observe that extreme high and low sales happen infrequently,
that is, they are not uniformly distributed.
• If your average weekly sales are $2000, for instance, two
adjacent weeks showing sales of $1,900 and $2,100 are more
probable than weeks of $0 and $4,000.
Lognormal Distribution
In probability theory, a log-normal (or lognormal) distribution is a continuous probability
distribution of a random variable whose logarithm is normally distributed. Thus, if the
random variable X is log-normally distributed, then Y = ln(X) has a normal distribution.
Equivalently, if Y has a normal distribution, then the exponential function of Y, X =
exp(Y), has a log-normal distribution. A random variable which is log-normally distributed
takes only positive real values.
Lognormal Distribution

• A distribution where the logarithm is normally distributed with

the mean and standard deviation. So the setup is similar to
the normal distribution, but please note that the mean and
standard_dev variables are meant to represent the logarithm.
Uniform distributions are probability distributions with equally likely outcomes. In a
discrete uniform distribution, outcomes are discrete and have the same probability. In a
continuous uniform distribution, outcomes are continuous and infinite.

Probability density function Cumulative distribution function

• =NORM.DIST(
• The arguments of the NORM.DIST function are listed as follows:
• X: This is the value for which we calculate the normal distribution.
• Mean: This is the average value of the distribution, i.e., the mean value.
• Standard Deviation: This is the standard deviation of the distribution.
• Cumulative: This is a logical value that determines the type of distribution
to be used.
• If the cumulative value is “true,” the function returns the cumulative normal
distribution function (CDF). If the cumulative value is “false,” the function
returns the normal probability density function (PDF).
 NORMINV Function
• The NORMINV function in Excel returns a number that is normally
distributed around a mean, altered by a standard deviation and by a
probability factor.
• In Excel, syntax for this function is
NORMINV(probability,mean,standard deviation).
• Using the sales example, with a weekly sales average of $2,000 that
fluctuates about $500 up or down, you know the mean and standard
deviation.
• You can use the RAND() function to establish probability and create a
random variable with normal distribution.
• Use the formula "=NORMINV(RAND(),B2,C2)", where the RAND()
function creates probability, B2 provides mean and C2 references
standard deviation.
• Change B2 and C2 to reference different cells or enter the values
into the formula itself. The combination of the two functions ensures
generation of a random variable with normal distribution.
NORM.S.INV Syntax

• NORM.S.INV(probability)
• Where probability (required) - This is the probability value
associated with the standard normal distribution, which must be
between 0 and 1 (exclusive).

The NORM.S.The INV Excel function is used to determine or

calculate the inverse normal cumulative distribution for a given
probability value.
• It returns the inverse of the standard normal cumulative
distribution. The distribution has a mean of zero and a standard
deviation of one.
• Given the probability that a variable is within a certain distance
of the mean, it calculates the z value (standard normal deviate),
where it corresponds to an area under the curve.
• Usually, the area should be between 0 and 1.
• The z value (standard normal deviate) corresponds to a one-
tailed probability P
• Calculate the Z-score for a probability value of 0.95.
=NORM.S.INV(0.95)

• In this example, the function returns approximately 1.645, which

is the Z-score corresponding to the 95th percentile of the
standard normal distribution. This value is often used in
hypothesis testing and confidence interval calculations.
Monte Carlo Simulation
• Monte Carlo Simulation is a process of using probability curves
to determine the likelihood of an outcome.
• This is done by running the simulation thousands of times and
analyzing the distribution of the output. This is particularly
important when you are analyzing the output of several
distribution curves that feed into one another.
Normal (Gaussian) Distribution

• This Monte Carlo Simulation Formula is characterized by being

evenly distributed on each side (median and mean is the same
– and no skewness). The tails of the curve go on to infinity.