Almira Arnaut-Berilo, Ph. D.

Sarajevo School of Economics and Business

Quantitative Methods in Economics
Trg Oslobođenja – Alija Izetbegović 1, 71000 Sarajevo, BiH
Phone: +387 33 275 954, e-mail: almira.arnaut@efsa.unsa.ba

Azra Zaimović, Ph. D.

Sarajevo School of Economics and Business
Financial, Portfolio and Risk Management
Trgo Oslobođenja – Alija Izetbegović 1, 71000 Sarajevo, BiH
Phone: +387 33 253 787, e-mail: azra.zaimovic@efsa.unsa.ba

Nedžmija Turbo - Merdan, MA

Sarajevo School of Economics and Business
e-mail: nedzmija_t@hotmail.com

EFFECTIVENESS OF MONTE CARLO SIMULATION AND ARIMA

MODEL IN PREDICTING STOCK PRICES

EFEKTIVNOST MONTE CARLO SIMULACIJE I ARIMA MODELA U

PREDIVĐANJU CIJENA DIONICA

ABSTRACT

The efficient market hypothesis states that stock prices are a reflection of information and rational
expectations, and all new information about the issuer are almost immediately reflected in the current stock
price. Stock prices should not be accurately predicted by looking at the historical prices. Stock prices could
be described by statistical process called “random walk”, i.e. single day’s deviations from the central value
are random and unpredictable.

The aim of this research is to test the effectiveness of Monte Carlo simulation model and Autoregressive
Integrated Moving Average model (ARIMA) in predicting stock prices. Selected methods use different input
data in predicting stock prices, including different time horizons; ARIMA model uses time series data to
predict future prices, while Monte Carlo simulation uses random walk component.

We compare daily predictions of stock prices estimated by both methods for five companies from Dow Jones
Industrial Average (DJIA) index. Predictions have been generated for one month period, from 10 th March
2016 until 10th April 2016. For the purpose of evaluation of prediction models we use Mean Absolute Error
(MAE), Mean Absolute Percent Error (MAPE), Mean Square Error (MSE) and Root Mean Square Error
(RMSE) methods.

We came to the conclusion that there is a slight advantage in accuracy of predictions of ARIMA model for
shorter periods (5 days), while Monte Carlo simulation has undoubted advantage for longer periods (21
days). Also, we noticed linkages between single stock’s predictions for periods of 5, 10 and 15 days for both
models.

Our results show that in shorter periods stock prices have elements of predictability, what questions the level
of efficiency of the world leading stock exchange. In longer periods (21 days) results indicate market
efficiency, i.e. model with random walk component (Monte Carlo simulation) has advantage compared to the
model based on historical prices (ARIMA).

Key words: Efficient Market Hypothesis, ARIMA Model, Monte Carlo Simulation, Random Walk

JEL: G11, G32

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 SAŽETAK
Hipotezom o efikasnosti tržišta tvrdi se da su cijene dionica odraz informacija i racionalnih očekivanja, te
da se sve nove informacije o emitentu gotovo odmah bivaju uključene u trenutnu cijenu dionice. Cijene
dionica se ne bi trebale moći precizno predvidjeti na bazi historijskih cijena. Drugim riječima, cijene dionica
se mogu opisati putem statističkog procesa nazvanog “slučajni hod”, tj. pojedinačna dnevna odstupanja od
srednje vrijednosti su slučajna i nepredvidiva.

Cilj ovog istraživanja je testiranje efektivnosti Monte Carlo simulacije i ARIMA modela u predviđanju cijena
dionica. Odabrane metode koriste različite ulazne podatke u predviđanju cijena dionica, uključujući različite
vremenske intervale; ARIMA model koristi vremensku seriju podataka u predviđanju budućih cijena, dok
Monte Carlo simulacija koristi element slučajnog hoda.

Mi poredimo dnevna predviđanja cijena dionica procijenjena na bazi obje metode za pet dionica iz indeksa
Dow Jones Industrial Average (DJIA). Predviđanja su generirana za jednomjesečni period, od 10. marta
2016. do 10. aprila 2016. godine. U svrhu procjene koji model predviđanja daje bolje rezultate koristimo
metode Mean Absolute Error (MAE), Mean Absolute Percent Error (MAPE), Mean Square Error (MSE) i
Root Mean Square Error (RMSE).

Došli smo do zaključka da je blaga prednost u tačnosti predviđanja na strani ARIMA modela za kraće
periode (5 dana), dok Monte Carlo simulacija ima nedvojbenu prednost kada se radi o dužim periodima
predviđanja (21 dan). Također, uočili smo povezanost između predviđanja za pojedinačne dionice za periode
od 5, 10 i 15 dana kod oba modela.

Naši rezultati pokazuju da cijene dionica imaju elemente predvidivosti u kraćim periodima, što dovodi u
pitanje nivo efikasnosti vodeće berze u svijetu. U dužim periodima (21 dan) rezultati upućuju na tržišnu
efikasnost, tj. model s komponentom slučajnog hoda (Monte Carlo simulacija) ima prednost u odnosu na
model baziran na historijskim cijenama (ARIMA).

Key words: hipoteza o efikasnosti tržišta, ARIMA model, Monte Carlo simulacija, slučajni hod

JEL: G11, G32

1. INTRODUCTION
Interest in the topic of predicting the movements of stock prices experienced its expansion in
1930’s, when world's stock exchanges started its faster development. Since then, this issue is
studied intensively and as a result a large number of different models that attempt to predict the
future path of movement of stock prices have been developed. Some of these models are neural
networks, fuzzy inference systems and machine learning techniques, various ARIMA models,
Monte Carlo simulation and GARCH model.
The aim of this research is to test the effectiveness of Monte Carlo (MC) simulation model and
Autoregressive Integrated Moving Average model (ARIMA) in predicting stock prices. Selected
methods use different input data in predicting stock prices, including different time horizons;
ARIMA model uses time series data to predict future prices, while Monte Carlo simulation uses
random walk component.
Monte Carlo simulation model is being used for valuation of options, while due to high volatility it
is not widely accepted for stock prices predictions. The aim of our research is to test whether the
MC model can be competitive to one of widely used models for short-term forecasting of stock
prices, namely ARIMA model. The basic idea of this research is to compare different models; the
sample selection, we think, doesn’t diminish the importance of the research.
We carried out analysis of comparison of the predicting power of two models on five companies
from Dow Jones Industrial Average (DJIA) listed on the New York Stock Exchange: Pfizer, Coca-
Cola, General Electric, Exxon and 3M. For an initial insight into the dynamics of stock prices, daily
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prices for all five companies are used in the period from March 2006 till March 2016. In the next
step, we forecasted stock prices by both models for one month period from 10th March till 10thApril
2016, i.e. 21 active trading days on NYSE. Individual forecasted prices are compared with actual
prices, and then forecasted prices by both models are compared to each other.
For comparison were used statistical tools for evaluating the accuracy of forecasting models (mean
absolute error, mean absolute percentage error and root mean square error).Vertical analysis is done
for deriving conclusions regarding the forecasting power of two models for time horizons of 5, 10,
15 and 21 days.
The paper is divided into five parts. Section 2 Literature review provides an overview of theoretical
background of the research on efficient markets and forecasting models, and shows the results on
previously conducted researches. Section 3 explains the methodology and data used for the analysis.
Section 4 gives the results of ARIMA and MC forecasting process. Finally, brief summary and
concluding remarks are given in Section 5.

2. LITERATURE REVIEW
Efficient market hypothesis (EMH) states that asset’s prices fully reflect all available information in
the market, so it is not possible to beat the market, since prices change only due to new information
or changes in investors’ required rates of return (Malkiel & Fama 1970). An implication of EMH is
that stocks are always in equilibrium, i.e. stocks trade at their fair value. It is impossible to gain
excessive returns or to outperform the market through fundamental or technical analysis and market
timing. Above average returns are connected with investments in riskier securities.
Random walk theory is stock market theory that stats that stock price changes are random, i.e. next
price changes are random from previous price. According to this theory stock price changes have
the same distribution and they are independent from each other, meaning that past movements of
stock prices or direction of stock prices cannot be used to predict future prices. The idea is that
information flow unhindered and all new information are immediately embedded in stock price, so
tomorrow’s stock price changes will reflect only tomorrow’s information, independent from today’s
price change. The idea is also referred to as the weak form of efficient market hypothesis. Dupernex
(2007) on the other hand states that random walk theory does not imply that stock market is
efficient with rational investors, as efficient market theory stats.
Dai and Zhang (2013) find US stock market semi-strong efficient, meaning that all publicly
available information is included in the current price. They used machine learning theory to confirm
the semi-strong efficiency; prediction of 3M stock next day price had low accuracy of 50%, while
the accuracy increased to 79% when authors tried to predict long-term trend.
Xu and Berkely (2012) used information from Yahoo Finance and Google Trend to simplify the
process of evaluation of online news. The author analyses Apple Inc. and combines the
conventional time series analysis technique (ARMA - autoregressive moving average) with the
information from the Internet to predict weekly changes in stock price. Important news related to a
selected stock over a five-year period are recorded and the weekly Google trend index values on
this stock are used to provide a measure of the magnitude of these events. The result of this
experiment has shown significant correlation between the changes in weekly stock prices and the
values of important news computed from the Google trend website. Author concludes that
algorithm proposed in this study can potentially outperform the conventional time series analysis in
stock price forecasting.
Autoregressive integrated moving average (ARIMA) is generalization of an autoregressive moving
average (ARMA) model fitted to time series data for their better understanding or forecasting future
values (Box, Jenkins & Reinsel, 1970). This model is one of the best methods in financial
forecasting, and different studies have shown its’ efficient ability of short-term forecasting (Ariyo,
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Adewumi & Ayo, 2014). ARIMA model is more robust and more efficient in time series
forecasting even then popular Artificial Neural Networks technic (Kyungjoo, Sehwan & John,
2007; Merh, Saxena & Pardasani, 2010; Sterba & Hilovska, 2010).
Mondal, Shit and Goswami (2014) conducted a test of ARIMA model on sample of 56 stocks from
seven sectors listed at the National Stock Exchange in India. The accuracy of predictions was above
85% for all sectors, with the best accuracy in consumer goods sector.
Monte Carlo (MC) simulation is a quantitative technic developed from John von Neumann during
the World War II (Eckhardt, 1987). The basic idea is using randomness to solve problems that
might be deterministic in principle. Monte Carlo simulation finds its application in much wider
areas then financial forecasting. Some examples we can see in papers from Tadeu et al. (2012),
Whiteside (2008), Hoesli et al. (2005) and Borkar et al. (2007).
Boyle (1976) shows that MC simulation is useful for option pricing when underlying stock returns
are generated as join of continues as well as sudden processes, and that it can be used for numerical
forecasting of European stock call options that pay dividends. Jabbour and Liu (2005) find that the
accuracy of MC simulation is increased by larger number of attempts in simulations.
Clewlow and Strickland (1998) and Hull (2012) state that MC is computer inadequate because of
the high generated variances. Landauskas (2011) in his paper compares standard MC simulation
with Markov chain MC simulation (MCMC). After 300 executed trajectories, average stock price
after 50 trades was very similar in both methods (18.08$ and 18.10$). Author also states that larger
number of intervals used in model development leads to higher accuracy, but also demands more
time to get result.

3. METHODOLOGY AND DATA

ARIMA model as one of the most prominent models for financial forecasting can be described as
follows:
Y t =φ 0+ φ1 Y t−1 +φ2 Y t−2 +…+ φ p Y t− p +ε t−θ 1 ε t−1−θ 2 ε t−2−θ q ε t−q , (1)
Where symbols represent
Y t – Forecasted stock price in period t (day, month, year or similar),
Y t − p – Real stock price in period t− p
φ p i θq – Coefficients,
pi q – Order of autoregressive component and moving average, respectively.
The main task of time series analysis is discovering of model that will appropriately describe the
process that is being generated by time series. Box-Jenkins approach to model selection is one of
the most often used methods for time-series analysis. This approach is characterized by four stages:
identification stage, estimation stage, diagnostic checking stage and forecasting stage (Bahovec and
Erjavec, 2009).
The application of the ARIMA methodology for time series analysis is due to Box and Jenkins
(1970). The general statistical methodology of ARIMA model can be presented as follows:
Step 1 - The model is identified for the observed data.
Step 2 - The model parameters are estimated.
Step 3 - If the hypotheses of the model are validated, go to Step 4, otherwise go to Step 1 to refine
the model.
Step 4 - The model is ready for forecasting.
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The main idea of MC simulation is to perform an experiment by simulation with probabilistic
components of system, whereby random numbers are being generated in order to assign values to
the components of system (Render, Stair and Hanna, 2012).
According to Crnjac-Milić and Masle (2013) MC simulation was found useful when stock returns
have been generated from continuous and discrete returns. MC simulation model is being derived
from Markov process, Wiener process and Brownian motion. If we analyze discrete time period,
model can be presented as follows:
∆ S=μS ∆ t +σSϵ √ Δt (2)
Where symbols represent
∆ S – Change in stock price,
μ – Stock return,
∆ t – Time in which stock price is being observed (day, month, year or similar),
S – Initial stock price or price from the last observed period,
σ – Standard deviation,
ϵ – Random component.
In equation (2), μ ∆ t is expected return, whileσϵ √ Δt is a stochastic component of return (Hull,
2012). Random component ϵ simulates Markov process, meaning that selected samples ofϵ should
be independent from each other.
For the comparison of the forecasts obtained through the Monte Carlo simulation and ARIMA
model, price movements for next five companies are analyzed: Pfizer, Coca-Cola, General Electric,
Exxon and 3M. These companies are part of Dow Jones Industrial Average (DJIA) index and they
are also quoted on the New York Stock Exchange (NYSE). The historical prices of all five
companies are analyzed in the period from March 2006 to March 2016. The aim is to test how the
results of the ARIMA model and Monte Carlo simulation are changed if the actual stock prices of
companies vary in different ways, regardless of the industry to which the company belongs. For
each model, a set of steps is implemented by using Eviews 9 SV and MS Excel 2010.
The prices are forecasted at the daily level for the period from 10 March to 10 April 2016, or 21
days of active trading. The observation period is divided into four parts: 5, 10, 15 and 21 trading
days. First, the individual forecasted prices for both models are compared with the actual ones.
Then, forecasted prices by both models are compared with each other. To help with the comparison,
statistics are used to evaluate the accuracy of prognostic models: mean absolute error (MAE), mean
absolute percentage error (MAPE) and root of a mean square error (RMSE).

4. RESULTS
The subsections below describe the processes of ARIMA model development for Pfizer Inc.
4.1 ARIMA model for Pfizer Inc.
Pfizer stock data used in this study cover the period from March 2006 to March 2016 having a total
number of 2507 observations. Figure 1 shows the original pattern of the series and gives a general
overview whether the time series is stationary or not. From the graph below we can see that the time
series have random walk pattern.

5
 Figure 1: Movements of daily closing prices of Pfizer Inc.Source by authors (Eviews 9 SV)

By visual analysis we can conclude that this is a non-stationary series that follows a random walk
pattern. The analysis of the correlogram provides additional confirmation that this is a non-
stationary series.
After the first differentiation of the series the graph and the correlogram indicate stationarity. In
order to obtain a formal confirmation that it is a stationary series after the first differentiation the
Augmented Dickey-Fuller (ADF) unit root test is obtained (Figure 2).

Figure 2: ADF unit root test for D(PFIZERCL). Source by authors (Eviews 9 SV)

In the analyzed case, the ADF test value is -37.84941, which is far less than the critical value of the
test (-3.43; -2.86; -2.56), which leads to a strong rejection of the zero hypothesis that D(PFIZERCL)
has a unit root, and accepting an alternative hypothesis that D(PFIZERCL) has no unit root with the
usual level of significance.
The parameter I in the ARIMA model measures the integrations of the model (I between AR and
MA) and in the case of the observed model it is 1, which means that the series is the first-order
differential. Table 1 shows the different parameters of the autoregressive (p) and moving average
(q) among the several ARIMA model experimented upon. Comparison is made so that the optimal
model is one which has: (1) the highest value of the coefficient of determination, (2) the lowest
value of the Schwarz information criterion and (3) the lowest standard error of regression. Among
the models of integration of order I =1 , the coefficient of determination is the highest for the model
(1, 1, 2). The standard error of regression is the lowest also for the model (1, 1, 2), and the Schwarz
information criterion is approximate to the parameters of other models of the order of integration
I =1, so this model is taken as optimal.
Table 1: Statistical results of different ARIMA parameters for Pfizer stock ( Source by authors)
Coeff. of determination Standard error of
ARIMA ( R2 ) Schwarz criterion regression
(1,0,0) 0.997180 0.542848 0.315767
(1,0,1) 0.997183 0.545029 0.315682
(1,1,1) 0.003735 0.537663 0.315311
(1,1,0) 0.000843 0.537434 0.315706
(0,1,1) 0.000948 0.537329 0.315689

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 (2,1,0) 0.002827 0.535448 0.315392
(0,1,2) 0.003088 0.535187 0.315351
(2,1,1) 0.003723 0.537672 0.315313
(1,1,2) 0.003979 0.537416 0.315273

The parameter estimation is done (Figure 3) using the method of Maximum Likelihood. The
coefficient AR (1) is at the limit of statistical significance at 5% and amounts -0.029924. The
coefficient MA (2) is statistically significant and amounts -0.058546. SIGMASQ is a mark for the
estimated variation of innovation or ''white noise''.

Figure 3: ARIMA (1,1,2) estimation output with D(PFIZERCL). Source by authors (Eviews 9 SV)

Based on the Durbin-Watson test results we conclude that there is no autocorrelation of residuals.
We also perform the autocorrelation test of residuals’ deviations and since there are no significant
spikes of ACFs and PACFs, it means that the residuals of the selected ARIMA model are white
noise, and no other significant patterns are left in the time series. Therefore, there is no need to
consider any AR (p) and MA (q) further.
The model (1, 1, 2) can be written as follows:
^
PFIZER =−0,029924 P FIZER −0,058546 ε t−2 +ε t . (3)
t t−1

The subsections below describe the processes of Monte Carlo simulation development for Pfizer
Inc.
4.2 Monte Carlo simulations for forecasting stock prices of Pfizer Inc.
The starting MC model for calculating the input data is presented and explained earlier (2):
∆ S=μS ∆ t +σSϵ √ Δt
Data on expected annual growth and standard deviation are determined based on historical prices.
We considered a period of 30 years (from 1985 to 2015) with an average annual return for that
period of 16.80% (μ = 0.16794) and a standard deviation of 33.66% (σ = 0.33665).
The price change is observed at the daily level as the results of the simulation are compared with
real prices within one month period of time. For this model, it is assumed that Pfizer stocks are
traded actively for 254 days a year, so one year is divided by the number of days in order to get the
required parameter. Thus, Δt = 1/254 or 0.00394, while the second root from Δt is 0.06275.
The real price (S) on 10th March was 30.5$, so the model can be written as:
Δ S = 0.16794∙ S ∙ 0.00394 + 0.33665∙ S∙ ϵ ∙ 0.06275 (4)
According to the Geometric Brownian motion on which the MC simulation is based, the model thus
presented means that the price of a stock follows a random walk. This is consistent with a weak

7
form of the efficient market hypothesis: past price information has already been incorporated and
subsequent price movements are conditionally independent from past price movements.
After 1000 simulations of the daily prices, the expected value was calculated and the result obtained
is the estimated daily stock price based on the MC model. The final result is visible in Table 2, in a
comparative view with the results of the ARIMA model predictions.
Table 2: Prices obtained through the forecast of two models in relation to the real prices of the stocks of
Pfizer (Source by authors).
Predicted
Sample Predicted
Actual Values Values
Period Values MC
ARIMA
1 30.10 29.40483 30.55675
2 29.54 29.50121 30.56519
3 29.04 29.41259 30.55577
4 29.34 29.49407 30.51950
5 29.45 29.41915 30.49679
6 30.07 29.48804 30.50409
7 30.38 29.42470 30.52727
8 30.19 29.48294 30.46389
9 30.08 29.42939 30.49685
10 29.78 29.47863 30.48413
11 30.05 29.43336 30.55115
12 30.07 29.47498 30.52850
13 29.64 29.43671 30.48524
14 30.04 29.47190 30.53086
15 30.72 29.43954 30.71015
16 31.36 29.46929 30.77961
17 32.93 29.44194 30.76318
18 32.76 29.46709 30.79568
19 32.5 29.44397 30.79217
20 31.89 29.46523 30.93653
21 31.96 29.44568 31.01251

We compare the ex post one week ahead forecasts of stock prices using three different evaluation
statistics to ensure that our inferences regarding the relative efficiency of the forecasting models are
not driven by the particular criterion used in these comparisons. The statistics are the Root Mean
Squared Error (RMSE), the Mean Absolute Error (MAE) and Mean Absolute Percent Error
(MAPE).
Table 3: Comparative ARIMA and MC model statistics for different periods of time for Pfizer Inc. (Source by
authors).

Time period
Model
5 days 10 days 15 days 21 day
The mean absolute error (MAE)
ARIMA model 0.25829 0.44877 0.51675 1.16276
MC model 1.04480 0.72002 0.63372 0.848865
Mean Absolute Percent Error ( MAPE)
ARIMA model 0.87074 1.49505 1.71510 3.67968
MC model 3.55643 2.43679 2.13855 2.74831
The root mean squared error (RMSE)
ARIMA model 0.36007 0.53977 0.61381 1.60025
MC model 1.09947 0.83659 0.749033 1.024226
Advantage ARIMA ARIMA ARIMA MC

In Table 3 we see that the statistics for the ARIMA model for periods of 5, 10 and 15 days are much
lower than the same indicators for the MC simulation. This means that the ARIMA model gives

8
results closer to the real ones. If the total period of 21 days is observed, MC simulation gives more
precise results.
4. 3 Comparative ARIMA model and Monte Carlo simulation model statistics
Similarly, the corresponding ARIMA models and MC models were selected for the remaining 4
stocks and the results of the comparisons are given in Tables 4 to 7.
Table 4: Comparative ARIMA and MC model statistics for different periods of time for Coca Cola (Source by
authors).
Coca Cola
ARIMA model ^
COCACOLA t =29.94265+0.999573 COCACOLA t−1 +0.998660 ε t −1+ ε t .
MC model Δ S=0.15943 ∙ S ∙ 0.00394+0.23938 ∙ S ∙ ϵ ∙ 0.06275
Time horizon
5 days 10 days 15 days 21 days
The mean absolute error (MAE)
ARIMA 0.868828 1.004986 1.338585 1.596852
MC 0.699725 0.784929 1.056698 1.219699
Mean Absolute Percent Error ( MAPE)
ARIMA 0.019147 0.022095 0.029117 0.034532
MC 0.015418 0.017257 0.022981 0.026378
The root mean squared error (RMSE)
ARIMA 0.901527 1.029633 1.444867 1.714948
MC 0.734412 0.807169 1.148668 1.310382
Advantage MC MC MC MC

Table 5: Comparative ARIMA and MC model statistics for different periods of time for General Electric
(Source by authors).
General Electric
ARIMA model ¿^ t =27.23002+0.998697 ¿t −1−0.231098 ε t −1+ ε t .
MC model Δ S=0. 14525∙ S ∙0.00394 +0.25661∙ S ∙ ϵ ∙ 0.06275
Time horizon
5 days 10 days 15 days 21 days
The mean absolute error (MAE)
ARIMA 0.353942 0.686105 1.020895 0.980553
MC 0.387337 0.64592 0.9259 0.814732
Mean Absolute Percent Error ( MAPE)
ARIMA 0.011556 0.022173 0.032544 0.031376
MC 0.012662 0.020895 0.029543 0.026057
The root mean squared error (RMSE)
ARIMA 0.455237 0.790311 1.175119 1.103603
MC 0.467556 0.720884 1.044524 0.935381
Advantage ARIMA MC MC MC

Table 6: Comparative ARIMA and MC model statistics for different periods of time for Exxon (Source by
authors).
Exxon
ARIMA model ^
EXXON t =79.03694+0.992641 EXXON t−1−0.152387 ε t −1 + ε t .
MC model Δ S=0.13012 ∙ S ∙ 0.00394+0.15147 ∙ S ∙ ϵ ∙0.06275
Time horizon
5 days 10 days 15 days 21 days
The mean absolute error (MAE)
ARIMA 0.51880 0.95413 1.11439 0.86722
MC 0.53117 0.92719 0.94768 0.79938
Mean Absolute Percent Error ( MAPE)
ARIMA 0.62197 1.13829 1.32680 1.30333
MC 0.63548 1.10566 1.12809 0.95426
The root mean squared error (RMSE)

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ARIMA 0.71518 1.12048 1.28306 0.98519
MC 0.78263 1.10219 1.11170 0.99400
Advantage ARIMA ARIMA ARIMA MC

Table 7: Comparative ARIMA and MC model statistics for different periods of time for 3M(Source by authors).
3M
ARIMA model 3^
M t=109.4349+ 0.9995293 M t−1−0.062219 ε t−1 +ε t .
MC model Δ S=0.13764 ∙ S ∙ 0.00394+ 0.19119∙ S ∙ ϵ ∙ 0.06275
Time horizon
5 days 10 days 15 days 21 days
The mean absolute error (MAE)
ARIMA 2.71791 3.88420 4.83041 5.47981
MC 2.25786 3.11321 3.81109 4.06980
Mean Absolute Percent Error ( MAPE)
ARIMA 1.67007 2.36747 2.92442 3.30713
MC 1.38759 1.89775 2.30753 2.45718
The root mean squared error (RMSE)
ARIMA 2.81926 4.09706 5.16102 5.78750
MC 2.32453 3.27595 4.06431 4.26339
Advantage MC MC MC MC

Based on selected criterions we find that ARIMA model has advantage in 3 out of 5 stocks in
sample in shortest time horizon of 5 days. It is interesting that advantage of ARIMA model
disappears with longer time horizons, and in the end MC model has advantage over ARIMA model
in all five cases for the longest time horizon of 21 days.
4. 4 Discussion of results
In order to get an insight of effectiveness of Monte Carlo simulation model and ARIMA model in
predicting stock prices, we forecasted stock prices of five stocks from DJIA in next 5, 10, 15 and 21
days from 10th March 2016 using the mentioned models. The main idea was to test how selected
methods that use different input data in predicting stock prices, including different time horizons are
effective in predicting stock prices. While ARIMA model uses time series data to predict future
prices, Monte Carlo simulation uses random walk component in predicting prices. The table 8
summarizes the advantages of applied models in predicting stock prices.
Table 8: Advantages of applied models for different time horizons (Source by authors).
TIME HORIZON
Company
5 DAYS 10 DAYS 15 DAYS 21 DAYS
Pfizer Inc. ARIMA ARIMA ARIMA MC
Coca-Cola MC MC MC MC
General Electric ARIMA MC MC MC
Exxon ARIMA ARIMA ARIMA MC
3M MC MC MC MC

Based on the results of the predicting power of both models, we can conclude that ARIMA model
has same advantage in predicting stock prices in shorter periods of time (5 days), while there is an
undoubted advantage on side of MC model for longer periods of time (21 days). Also, we noticed
linkages between single stocks predictions in a way that there is only one change in advantage from
one method to another, and that advantage of MC method is increasing with the lengthening of the
time.
The persistence in quality of predictions of one or other method leads us to the possible
generalization of results. It is especially interesting that MC can be seen as method of better quality
in predicting stock prices with time lag of 21 days. MC simulation model is formed to describe
random walk pattern, and weak form market efficiency assume that future securities' prices are
random and not influenced by past events. Is it possible that assumption about day’s stock prices
reflect all the data of past prices is being satisfied with some time lag? We assume that market time
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lag appears due to information imperfection or some other process of market information
absorption, after what they are being included in the market price.

5. CONCLUSION
This paper analyzes the effectiveness of Monte Carlo simulations and ARIMA model in predicting
stock prices. Our results show that in shorter period stock prices have elements of predictability
according to historical price, what questions the level of efficiency of the world leading stock
exchange. In longer periods (21 days) results indicate weak-form market efficiency, i.e. model with
random walk component (Monte Carlo simulation) has advantage compared to the model based on
historical prices (ARIMA). A combination of these findings could provide useful information to
investors when to buy or sell stocks and Monte Carlo simulation could be used to determine which
stock to sell short.
We consider that this research can be extend in two ways: (1) for possible generalization of
obtained conclusions about advantages of one or the other method in predicting stock prices for
which we suggest the expansion of sample and (2) further analysis of time lag needed to absorb new
information in market and its’ inclusion in the stock price as according to MC model which is based
on random walk principle.
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