Simulation of conditional expectations under fast mean-reverting stochastic volatility models

Andrei Cozma and Christoph Reisinger

Papers from arXiv.org

Abstract: In this short paper, we study the simulation of a large system of stochastic processes subject to a common driving noise and fast mean-reverting stochastic volatilities. This model may be used to describe the firm values of a large pool of financial entities. We then seek an efficient estimator for the probability of a default, indicated by a firm value below a certain threshold, conditional on common factors. We consider approximations where coefficients containing the fast volatility are replaced by certain ergodic averages (a type of law of large numbers), and study a correction term (of central limit theorem-type). The accuracy of these approximations is assessed by numerical simulation of pathwise losses and the estimation of payoff functions as they appear in basket credit derivatives.

Date: 2020-12, Revised 2021-10
New Economics Papers: this item is included in nep-cmp
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:2012.09726

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