Quotation Geyer, Alois, Hanke, Michael, Weissensteiner, Alex. 2014. No-Arbitrage ROM Simulation. Journal of Economic Dynamics & Control 45, 66-79.


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Abstract

Ledermann et al. (2011) propose random orthogonal matrix (ROM) simulation for generating multivariate samples matching means and covariances exactly. Its computational efficiency compared to standard Monte Carlo methods makes it an interesting alternative. In this paper we enhance this method?s attractiveness by focusing on applications in finance. Many financial applications require simulated asset returns to be free of arbitrage opportunities. We analytically derive no-arbitrage bounds for expected excess returns to be used in the context of ROM simulation, and we establish the theoretical relation between the number of states (i.e., the sample size) and the size of (no-)arbitrage regions. Based on these results, we present a No-Arbitrage ROM simulation algorithm, which generates arbitrage-free random samples by purposefully rotating a simplex. Hence, the proposed algorithm completely avoids any need for checking samples for arbitrage. Compared to the alternative of (potentially frequent) re-sampling followed by arbitrage checks, it is considerably more efficient. As a by-product, we provide interesting geometrical insights into affine transformations associated with the No-Arbitrage ROM simulation algorithm.

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Publication's profile

Status of publication Published
Affiliation WU
Type of publication Journal article
Journal Journal of Economic Dynamics & Control
Citation Index SSCI
WU Journalrating 2009 A
WU-Journal-Rating new FIN-A, INF-A, STRAT-A, VW-B, WH-A
Language English
Title No-Arbitrage ROM Simulation
Volume 45
Year 2014
Page from 66
Page to 79
Reviewed? Y
URL http://www.sciencedirect.com/science/article/pii/S0165188914001250
DOI http://dx.doi.org/10.1016/j.jedc.2014.05.017

Associations

Projects
Arbitrage-free scenario trees for financial optimization
People
Geyer, Alois (Details)
Hanke, Michael (Former researcher)
External
Weissensteiner, Alex (School of Economics and Management, Bolzano and Technical University of Denmark, Italy)
Organization
Institute for Financial Research IN (Details)
Competence Center for Empirical Research Methods WE (Details)
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