Model Uncertainty and Scenario Aggregation
Mathematical Finance, Forthcoming
34 Pages Posted: 25 May 2014 Last revised: 28 Nov 2015
Date Written: February 2, 2014
This paper provides a coherent method for scenario aggregation addressing model uncertainty. It is based on divergence minimization from a reference probability measure subject to scenario constraints. An example from regulatory practice motivates the definition of five fundamental criteria that serve as a basis for our method. Standard risk measures, such as value-at-risk and expected shortfall, are shown to be robust with respect to minimum divergence scenario aggregation. Various examples illustrate the tractability of our method.
Keywords: model uncertainty, scenario aggregation, expected shortfall, value-at-risk, statistical divergence, Swiss Solvency Test
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