Sparse economic scenarios
35 Pages Posted: 22 Mar 2019 Last revised: 5 Aug 2020
Date Written: March 22, 2019
We show how to reduce financial asset prices to low-dimensional scenario trees. Applied to time series, the scenarios and their probabilities become time-varying factors. From S&P 500 options, two or three time-varying scenarios suffice to forecast returns, implied variance or skewness on par, or better, than extant multivariate stochastic volatility jump-diffusion models, while reducing the computational effort to fractions of a second.
Keywords: scenario generation, moment problem, quadrature, prediction, options
JEL Classification: G13, G02, G17, C02, C14, C46, C52, C53
Suggested Citation: Suggested Citation