Model Uncertainty and Scenario Aggregation

Mathematical Finance, Forthcoming

Swiss Finance Institute Research Paper No. 14-38

34 Pages Posted: 25 May 2014 Last revised: 28 Nov 2015

See all articles by Mathieu Cambou

Mathieu Cambou

Ecole Polytechnique Fédérale de Lausanne

Damir Filipović

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Date Written: February 2, 2014

Abstract

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

Suggested Citation

Cambou, Mathieu and Filipovic, Damir, Model Uncertainty and Scenario Aggregation (February 2, 2014). Mathematical Finance, Forthcoming; Swiss Finance Institute Research Paper No. 14-38. Available at SSRN: https://ssrn.com/abstract=2441328 or http://dx.doi.org/10.2139/ssrn.2441328

Mathieu Cambou

Ecole Polytechnique Fédérale de Lausanne ( email )

Station 5
Odyssea 1.04
1015 Lausanne, CH-1015
Switzerland

Damir Filipovic (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

Odyssea
Station 5
Lausanne, 1015
Switzerland

HOME PAGE: http://people.epfl.ch/damir.filipovic

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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