Error Analysis of a Model Order Reduction Framework for Financial Risk Analysis

Andreas Binder, Onkar Jadhav and Volker Mehrmann
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Andreas Binder: MathConsult GmbH, Linz, Austria
Onkar Jadhav: MathConsult GmbH, Linz, Austria
Volker Mehrmann: Institute of Mathematics, TU Berlin, Berlin, Germany

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Abstract: A parametric model order reduction (MOR) approach for simulating the high dimensional models arising in financial risk analysis is proposed on the basis of the proper orthogonal decomposition (POD) approach to generate small model approximations for the high dimensional parametric convection-diffusion reaction partial differential equations (PDE). The proposed technique uses an adaptive greedy sampling approach based on surrogate modeling to efficiently locate the most relevant training parameters, thus generating the optimal reduced basis. The best suitable reduced model is procured such that the total error is less than a user-defined tolerance. The three major errors considered are the discretization error associated with the full model obtained by discretizing the PDE, the model order reduction error, and the parameter sampling error. The developed technique is analyzed, implemented, and tested on industrial data of a puttable steepener under the two-factor Hull-White model. The results illustrate that the reduced model provides a significant speedup with excellent accuracy over a full model approach, demonstrating its potential applications in the historical or Monte Carlo value at risk calculations.

Date: 2021-10
New Economics Papers: this item is included in nep-cwa, nep-ore and nep-rmg
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