Multilevel nested simulation for efficient risk estimation

Michael B. Giles, Abdul-Lateef Haji-Ali

Research output: Contribution to journalArticle

3 Citations (Scopus)
31 Downloads (Pure)

Abstract

We investigate the problem of computing a nested expectation of the form P[E[X| Y ]≥ 0] = E[H(E[X| Y ])] where H is the Heaviside function. This nested expectation appears, for example, when estimating the probability of a large loss from a financial portfolio. We present a method that combines the idea of using Multilevel Monte Carlo (MLMC) for nested expectations with the idea of adaptively selecting the number of samples in the approximation of the inner expectation, as proposed by [M. Broadie, Y. Du, and C. C. Moallemi, Manag. Sci., 57 (2011), pp. 1172- 1194]. We propose and analyze an algorithm that adaptively selects the number of inner samples on each MLMC level and prove that the resulting MLMC method with adaptive sampling has an O (ϵ -2| logϵ| 2) complexity to achieve a root mean-squared error ϵ . The theoretical analysis is verified by numerical experiments on a simple model problem. We also present a stochastic root-finding algorithm that, combined with our adaptive methods, can be used to compute other risk measures such as Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR), the latter being achieved with O (ϵ -2) complexity.

Original languageEnglish
Pages (from-to)497–525
Number of pages29
JournalSIAM/ASA Journal on Uncertainty Quantification
Volume7
Issue number2
Early online date2 May 2019
DOIs
Publication statusPublished - 2019

Keywords

  • Monte Carlo
  • Multilevel Monte Carlo
  • Nested simulation
  • Risk estimation

ASJC Scopus subject areas

  • Statistics and Probability
  • Modelling and Simulation
  • Statistics, Probability and Uncertainty
  • Discrete Mathematics and Combinatorics
  • Applied Mathematics

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