Dynamic stochastic programming (DSP) provides an
intuitive framework for modelling of financial portfolio choice
problems where market frictions are present and dynamic
re--balancing has a significant effect on initial decisions. The
application of these models in practice, however, is limited by
the quality and size of the event trees representing the
underlying uncertainty. Most often the DSP literature assumes
existence of ``appropriate'' event trees without defining and
examining qualities that must be met (ex--ante) in such an event
tree in order for the results of the DSP model to be reliable.
Indeed defining a universal and tractable framework for fully
``appropriate'' event trees is in our opinion an impossible task.
A problem specific approach to designing such event trees is the
way ahead. In this paper we propose a number of desirable
properties which should be present in an event tree of yield
curves. Such trees may then be used to represent the underlying
uncertainty in DSP models of fixed income risk and portfolio
- Interest rate modeling, scenario tree generation.