A parsimonious model for generating arbitrage-free scenario trees

Andrea Consiglio, Angelo Carollo, Stavros A. Zenios

Risultato della ricerca: Articlepeer review

23 Citazioni (Scopus)


Simulation models of economic, financial and business risk factors are widely used to assess risks and support decision-making. Extensive literature on scenario generation methods aims at describing some underlying stochastic processes with the least number of scenarios to overcome the ‘curse of dimensionality’. There is, however, an important requirement that is usually overlooked when one departs from the application domain of security pricing: the no-arbitrage condition. We formulate a moment matching model to generate multi-factor scenario trees for stochastic optimization satisfying no-arbitrage restrictions with a minimal number of scenarios and without any distributional assumptions. The resulting global optimization problem is quite general. However, it is non-convex and can grow significantly with the number of risk factors, and we develop convex lower bounding techniques for its solution exploiting the special structure of the problem. Applications to some standard problems from the literature show that this is a robust approach for tree generation. We use it to price a European basket option in complete and incomplete markets.
Lingua originaleEnglish
pagine (da-a)201-212
Numero di pagine12
RivistaQuantitative Finance
Stato di pubblicazionePublished - 2016

All Science Journal Classification (ASJC) codes

  • ???subjectarea.asjc.2000.2003???
  • ???subjectarea.asjc.2000.2000???


Entra nei temi di ricerca di 'A parsimonious model for generating arbitrage-free scenario trees'. Insieme formano una fingerprint unica.

Cita questo