Simulation-based Value-at-Risk for nonlinear portfolios. Issue 10 (3rd October 2019)

• Record Type: Journal Article
• Authors: Chen, Junyao; Sit, Tony; Wong, Hoi Ying
• Is Part Of: Quantitative finance. Volume 19:Issue 10(2019)
• Page Start: 1639
• Page End: 1658
• Publication Date: 2019-10-03
• Subjects: Value-at-risk -- Least-squares Monte Carlo -- American-type derivatives -- High-dimensional portfolios; Finance -- Periodicals; Business mathematics -- Periodicals; Finance -- Mathematical models -- Periodicals; Investments -- Mathematics -- Periodicals; Economics -- Periodicals; Finances -- Modèles mathématiques -- Périodiques; 332.015118
• DOI: 10.1080/14697688.2019.1598568
• Languages: English
• ISSNs: 1469-7688

Abstract

Abstract : Value-at-risk (VaR) has been playing the role of a standard risk measure since its introduction. In practice, the delta-normal approach is usually adopted to approximate the VaR of portfolios with option positions. Its effectiveness, however, substantially diminishes when the portfolios concerned involve a high dimension of derivative positions with nonlinear payoffs; lack of closed form pricing solution for these potentially highly correlated, American-style derivatives further complicate the problem. This paper proposes a generic simulation-based algorithm for VaR estimation that can be easily applied to any existing procedures. Our proposal leverages cross-sectional information and applies variable selection techniques to simplify the existing simulation framework. Asymptotic properties of the new approach demonstrate faster convergence due to the additional model selection component introduced. We have also performed sets of numerical results that verify the effectiveness of our approach in comparison with some existing strategies.