Principles of Financial Modelling

CHAPTER 12Sensitivity and Scenario Analysis: Core Techniques

INTRODUCTION

This chapter introduces the techniques required to conduct sensitivity and scenario analyses. At the most basic level, these can be used to answer What if? questions, and often represent an important part of providing appropriate decision support. In addition, as covered earlier, sensitivity-related techniques are a key part of all stages of the modelling process, from model design to final use. The first section of this chapter provides an overview of ways to conduct sensitivity analysis and of related tools. The second section describes one of these in detail, namely Excel's DataTable functionality. The third section shows some examples using this functionality, including the running of sensitivity and scenario analysis. The later chapters cover the details of the other approaches to sensitivity analysis.

OVERVIEW OF SENSITIVITY-RELATED TECHNIQUES

There are several simplistic ways to conduct sensitivity analysis:

• To manually change an input value and note the effect on an output. Whilst this is a very useful way to test a formula as it is being built, it would be cumbersome and inefficient to use this to conduct sensitivities on a completed model:
  • One would need to make a note of the input values used and the resulting output values, which would be cumbersome when several input values are to be changed.
  • The analysis would need to be repeated if the model is modified in any way, since there is no ...