Efficient Simulation of Value-at-Risk Under a Jump Diffusion Model: A New Method for Moderate Deviation Events

Cheng Der Fuh, Huei-Wen Teng, Ren Her Wang*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

Importance sampling is a powerful variance reduction technique for rare event simulation, and can be applied to evaluate a portfolio’s Value-at-Risk (VaR). By adding a jump term in the geometric Brownian motion, the jump diffusion model can be used to describe abnormal changes in asset prices when there is a serious event in the market. In this paper, we propose an importance sampling algorithm to compute the portfolio’s VaR under a multi-variate jump diffusion model. To be more precise, an efficient computational procedure is developed for estimating the portfolio loss probability for those assets with jump risks. And the tilting measure can be separated for the diffusion and the jump part under the assumption of independence. The simulation results show that the efficiency of importance sampling improves over the naive Monte Carlo simulation from 9 to 277 times under various situations.

Original languageEnglish
Pages (from-to)973-990
Number of pages18
JournalComputational Economics
Volume51
Issue number4
DOIs
StatePublished - 1 Apr 2018

Keywords

  • Exponential tilting
  • Importance sampling
  • Jump diffusion
  • Moderate deviation
  • VaR

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