Scenario tree generation and multi-asset financial optimization problems

Alois Geyer, Michael Hanke, Alex Weissensteiner

    Research output: Contribution to journalJournal articleResearchpeer-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 languageEnglish
    JournalOperations Research Letters
    Volume41
    Issue number5
    Pages (from-to)494-498
    ISSN0167-6377
    DOIs
    Publication statusPublished - 2013

    Keywords

    • Scenario trees
    • No-arbitrage
    • Financial optimization
    • Moment matching
    • Scenario reduction

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