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

Cheng- Der Fuh (), Huei-Wen Teng () and Ren-Her Wang ()
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Cheng- Der Fuh: National Central University
Huei-Wen Teng: National Chiao Tung University
Ren-Her Wang: Tamkang University

Computational Economics, 2018, vol. 51, issue 4, No 11, 973-990

Abstract: 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.

Keywords: Importance sampling; Exponential tilting; Moderate deviation; Jump diffusion; VaR; 90-08; 65K10 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1007/s10614-017-9654-z

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