The article “No-Arbitrage Bounds for Financial Scenarios”, written by Professor Michael Hanke from the Institute for Financial Services together with co-authors from the Vienna University of Economics and Business and the Technical University of Denmark in Copenhagen, has been accepted for publication in ELSEVIER’s European Journal of Operational Research.
The article “No-Arbitrage Bounds for Financial Scenarios”, written by Professor Michael Hanke from the Institute for Financial Services together with co-authors from the Vienna University of Economics and Business and the Technical University of Denmark in Copenhagen, has been accepted for publication in ELSEVIER’s European Journal of Operational Research.
The European Journal of Operational Research is a leading international journal in the field of quantitative business administration (“A” rating in the VHB ranking as well as numerous other rankings).
The paper, written by Professor Michael Hanke and his colleagues Professor Alois Geyer from the Vienna University of Economics and Business and Professor Alex Weissensteiner from the Technical University of Denmark in Copenhagen, analyses the use of scenario trees in the context of stochastic optimization. While this approach is successfully applied in other fields – such as the energy sector and industry – directly transferring it to problems in the financial sector is difficult. Instead, an additional condition, known as freedom of arbitrage, is required for the financial sector.
Saving resources thanks to research findings
The article analyses the theoretical coherences between the distributions to be modelled, the size of the scenario trees and the required level of arbitrage freedom based on very general assumptions. The previous approach in this field involved generating trees and subsequently checking arbitrage freedom. Scenario trees that did not pass this test had to be discarded and the procedure had to be repeated.
The insights gained from the work of Professor Hanke and his colleagues, which is the result of a project supported by the University of Liechtenstein’s research promotion fund (FFF), mean arbitrage freedom can be tested before the (computationally intensive) process of generating scenario trees, contrary to the previous method, thereby avoiding the unnecessary use of resources.
The paper can already be accessed online at www.sciencedirect.com/science/article/pii/S0377221710002213