Scenario Tree Generation and Multi-Asset Financial Optimization Problems

Operations Research Letters, 2013, 41, 494-498

15 Pages Posted: 3 Jun 2011 Last revised: 1 Jul 2017

See all articles by Alois Geyer

Alois Geyer

VGSF / WU

Michael Hanke

University of Liechtenstein

Alex Weissensteiner

Free University of Bolzano Bozen

Date Written: April 18, 2011

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, we find that moment matching, when accompanied by a check to ensure the absence of arbitrage opportunities, exactly replicates this solution. On the other hand, even if the scenario trees generated by scenario reduction are arbitrage-free, the solutions to the approximate optimization problem represented by the reduced tree are highly variable. As a conclusion we strongly favor moment matching over scenario reduction for multi-asset financial optimization problems.

The published version differs from this working paper version.

Keywords: Scenario trees, No arbitrage, Financial optimization, Scenario reduction

Suggested Citation

Geyer, Alois and Hanke, Michael and Weissensteiner, Alex, Scenario Tree Generation and Multi-Asset Financial Optimization Problems (April 18, 2011). Operations Research Letters, 2013, 41, 494-498. Available at SSRN: https://ssrn.com/abstract=1857411 or http://dx.doi.org/10.2139/ssrn.1857411

Alois Geyer (Contact Author)

VGSF / WU ( email )

Welthandelsplatz 1
Institute for Financial Research
Vienna, 1020
Austria

HOME PAGE: http://www.wu.ac.at/~geyer

Michael Hanke

University of Liechtenstein ( email )

Fuerst Franz Josef-Strasse
Vaduz, FL-9490
Liechtenstein

Alex Weissensteiner

Free University of Bolzano Bozen ( email )

Universitätsplatz 1
Bolzano, 39100
+39 0471 013496 (Phone)

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