Term Structure Models in Multistage Stochastic Programming: Estimation and Approximation
Annals of Operations Research
This paper investigates some common interest rate models for scenario generation in financial applications of stochastic optimization. We discuss conditions for the underlying distributions of state variables which preserve convexity of value functions in a multistage stochastic program. One- and multi-factor term structure models are estimated based on historical data for the Swiss Franc. An analysis of the dynamic behavior of interest rates generated with these models reveals several deficiencies which have an impact on the performance of investment policies derived from the stochastic program. While barycentric approximation is used here for the generation of scenario trees, these insights may be generalized to other discretization techniques as well.
Multistage Stochastic Programming
Asset & Liability Management
Non-Maturing Assets & Liabilities
contribution to scientific community