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Least squares Monte Carlo applied to dynamic monetary utility functions
Stockholms universitet, Naturvetenskapliga fakulteten, Matematiska institutionen.ORCID-id: 0000-0001-5610-1079
(engelsk)Manuskript (preprint) (Annet vitenskapelig)
Abstract [en]

In this paper we explore ways of numerically computing recursive dynamic monetary risk measures and utility functions. Computationally, this problem suffers from the curse of dimensionality and nested simulations are unfeasible if there are more than two time steps. The approach considered in this paper is to use a Least Squares Monte Carlo (LSM) algorithm to tackle this problem, a method which has been primarily considered for valuing American derivatives, or more general stopping time problems, as these also give rise to backward recursions with corresponding challenges in terms of numerical computation. We give some overarching consistency results for the LSM algorithm in a general setting as well as explore numerically its performance for recursive Cost-of-Capital valuation, a special case of a dynamic monetary utility function.

HSV kategori
Forskningsprogram
matematisk statistik; matematik
Identifikatorer
URN: urn:nbn:se:su:diva-192123OAI: oai:DiVA.org:su-192123DiVA, id: diva2:1543834
Tilgjengelig fra: 2021-04-13 Laget: 2021-04-13 Sist oppdatert: 2022-02-25
Inngår i avhandling
1. Dynamic valuation of insurance cash flows subject to capital requirements
Åpne denne publikasjonen i ny fane eller vindu >>Dynamic valuation of insurance cash flows subject to capital requirements
2021 (engelsk)Doktoravhandling, med artikler (Annet vitenskapelig)
Abstract [en]

Insurance companies are required by regulation to be in possession of liquid assets that ensure that they can meet their obligations to policyholders with high probability. The amount is usually determined by an actuarial valuation, with for instance the Solvency II regulatory framework providing standard formulae. In this thesis we investigate a valuation procedure where the value of a liability cash flow is determined via a backwards recursive relationship, meaning that the value at time t depends on the value at time t+1. The value corresponds to an amount required to be able to raise capital from an external capital provider with limited liability, in order to meet capital requirements imposed by a regulating body. 

Paper I describes the valuation philosophy that will more or less be shared by all papers in the thesis. It establishes a recursive relationship given via a mapping, that satisfy the properties of a dynamic monetary utility function. Conditions are given where finite p:th moments are preserved in the recursion and a link to the well known subject of dynamic monetary risk measures and utility functions is established. The structure of the recursion is used to find closed-form values for certain stochastic processes, most importantly in the case where we have jointly Gaussian cash flows.

Paper II explores the valuation procedure in the presence of a risk-neutral probability measure, which correctly prices the financial instruments that are priced by the financial market but is also assumed to express the risk aversion toward non-hedgeable insurance risk of the capital provider. We show that the valuation procedure is equivalent to an optimal stopping problem, giving us an alternative way to define the valuation procedure. We reproduce many of the structural results from Paper I under the assumed conditions. We also consider the choice of replicating portfolio under different criteria, especially the criterion of minimizing the need for external capital.

Paper III considers the discrete-time valuation from paper I, but where the valuation times form an arbitrary partition of the time interval on which the runoff of the liability occurs. We investigate the properties of the value as the mesh of the partition goes to zero. We define a "continuous-time value" of a liability cash flow and find closed form expressions and some structural results for classes of stochastic processes including Lévy processes and Itô diffusions.

Paper IV tackles the numerical difficulties of performing the recursive valuation procedure where a closed-form value cannot be found. Under Markovian assumptions, a so-called least-squares Monte Carlo (LSM) algorithm is investigated, a method that was developed to tackle optimal stopping problems. We show some overarching consistency results for the LSM algorithm in the general setting of dynamic monetary utility functions and also explore numeric performance for some example models.

sted, utgiver, år, opplag, sider
Stockholm: Department of Mathematics, Stockholm University, 2021. s. 31
Emneord
Valuation, Risk measures
HSV kategori
Forskningsprogram
matematisk statistik
Identifikatorer
urn:nbn:se:su:diva-192125 (URN)978-91-7911-484-8 (ISBN)978-91-7911-485-5 (ISBN)
Disputas
2021-05-28, online via Zoom, public link is available at the department website, 13:00 (engelsk)
Opponent
Veileder
Tilgjengelig fra: 2021-05-05 Laget: 2021-04-13 Sist oppdatert: 2022-02-25bibliografisk kontrollert

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