Scenario tree generation and multi-asset financial optimization problems

Alois Geyer; Michael Hanke; Alex Weissensteiner

doi:10.1016/j.orl.2013.06.003

Scenario tree generation and multi-asset financial optimization problems

Alois Geyer, Michael Hanke, Alex Weissensteiner

Research output: Contribution to journal › Journal article › Research › peer-review

Abstract

We compare two popular scenario tree generation methods in the context of financial optimization: moment matching and scenario reduction. Using a simple problem with a known analytic solution, moment matching-when ensuring absence of arbitrage-replicates this solution precisely. On the other hand, even if the scenario trees generated by scenario reduction are arbitrage-free, the solutions are biased and highly variable. These results hold for correlated and uncorrelated asset returns, as well as for normal and non-normal returns. © 2013 Elsevier B.V. All rights reserved.

Original language	English
Journal	Operations Research Letters
Volume	41
Issue number	5
Pages (from-to)	494-498
ISSN	0167-6377
DOIs	https://doi.org/10.1016/j.orl.2013.06.003
Publication status	Published - 2013

Keywords

Scenario trees
No-arbitrage
Financial optimization
Moment matching
Scenario reduction

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title = "Scenario tree generation and multi-asset financial optimization problems",

abstract = "We compare two popular scenario tree generation methods in the context of financial optimization: moment matching and scenario reduction. Using a simple problem with a known analytic solution, moment matching-when ensuring absence of arbitrage-replicates this solution precisely. On the other hand, even if the scenario trees generated by scenario reduction are arbitrage-free, the solutions are biased and highly variable. These results hold for correlated and uncorrelated asset returns, as well as for normal and non-normal returns. {\textcopyright} 2013 Elsevier B.V. All rights reserved.",

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AB - We compare two popular scenario tree generation methods in the context of financial optimization: moment matching and scenario reduction. Using a simple problem with a known analytic solution, moment matching-when ensuring absence of arbitrage-replicates this solution precisely. On the other hand, even if the scenario trees generated by scenario reduction are arbitrage-free, the solutions are biased and highly variable. These results hold for correlated and uncorrelated asset returns, as well as for normal and non-normal returns. © 2013 Elsevier B.V. All rights reserved.

KW - Scenario trees

KW - No-arbitrage

KW - Financial optimization

KW - Moment matching

KW - Scenario reduction

U2 - 10.1016/j.orl.2013.06.003

DO - 10.1016/j.orl.2013.06.003

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JO - Operations Research Letters

JF - Operations Research Letters

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Scenario tree generation and multi-asset financial optimization problems

Abstract

Keywords

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