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Sensitivity Estimates from Characteristic Functions

Author

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  • Paul Glasserman

    (Columbia Business School, Columbia University, New York, New York 10027)

  • Zongjian Liu

    (IEOR Department, Columbia University, New York, New York 10027)

Abstract

The likelihood ratio method (LRM) is a technique for estimating derivatives of expectations through simulation. LRM estimators are constructed from the derivatives of probability densities of inputs to a simulation. We investigate the application of the likelihood ratio method for sensitivity estimation when the relevant densities for the underlying model are known only through their characteristic functions or Laplace transforms. This problem arises in financial applications, where sensitivities are used for managing risk and where a substantial class of models have transition densities known only through their transforms. We quantify various sources of errors arising when numerical transform inversion is used to sample through the characteristic function and to evaluate the density and its derivative, as required in LRM. This analysis provides guidance for setting parameters in the method to accelerate convergence.

Suggested Citation

  • Paul Glasserman & Zongjian Liu, 2010. "Sensitivity Estimates from Characteristic Functions," Operations Research, INFORMS, vol. 58(6), pages 1611-1623, December.
    • Handle: RePEc:inm:oropre:v:58:y:2010:i:6:p:1611-1623
    DOI: 10.1287/opre.1100.0837
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    References listed on IDEAS

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    Cited by:

    1. Michele Azzone & Roberto Baviera, 2021. "A fast Monte Carlo scheme for additive processes and option pricing," Papers 2112.08291, arXiv.org, revised Jul 2023.
    2. Svetlana Boyarchenko & Sergei Levendorskii, 2023. "Simulation of a L\'evy process, its extremum, and hitting time of the extremum via characteristic functions," Papers 2312.03929, arXiv.org.
    3. Leitao, Álvaro & Oosterlee, Cornelis W. & Ortiz-Gracia, Luis & Bohte, Sander M., 2018. "On the data-driven COS method," Applied Mathematics and Computation, Elsevier, vol. 317(C), pages 68-84.
    4. Muroi, Yoshifumi & Suda, Shintaro, 2017. "Computation of Greeks in jump-diffusion models using discrete Malliavin calculus," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 140(C), pages 69-93.
    5. Pingping Zeng & Ziqing Xu & Pingping Jiang & Yue Kuen Kwok, 2023. "Analytical solvability and exact simulation in models with affine stochastic volatility and Lévy jumps," Mathematical Finance, Wiley Blackwell, vol. 33(3), pages 842-890, July.
    6. Xuefei Lu & Alessandro Rudi & Emanuele Borgonovo & Lorenzo Rosasco, 2020. "Faster Kriging: Facing High-Dimensional Simulators," Operations Research, INFORMS, vol. 68(1), pages 233-249, January.
    7. Denis Belomestny & Leonid Iosipoi, 2019. "Fourier transform MCMC, heavy tailed distributions and geometric ergodicity," Papers 1909.00698, arXiv.org, revised Dec 2019.
    8. Belomestny, Denis & Iosipoi, Leonid, 2021. "Fourier transform MCMC, heavy-tailed distributions, and geometric ergodicity," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 181(C), pages 351-363.
    9. Abootaleb Shirvani & Svetlozar T. Rachev & Frank J. Fabozzi, 2019. "Multiple Subordinated Modeling of Asset Returns," Papers 1907.12600, arXiv.org.
    10. Yijie Peng & Michael C. Fu & Jian-Qiang Hu, 2016. "Gradient-based simulated maximum likelihood estimation for stochastic volatility models using characteristic functions," Quantitative Finance, Taylor & Francis Journals, vol. 16(9), pages 1393-1411, September.
    11. Isadora Antoniano‐Villalobos & Emanuele Borgonovo & Sumeda Siriwardena, 2018. "Which Parameters Are Important? Differential Importance Under Uncertainty," Risk Analysis, John Wiley & Sons, vol. 38(11), pages 2459-2477, November.
    12. Svetlana Boyarchenko & Sergei Levendorskiĭ, 2019. "Sinh-Acceleration: Efficient Evaluation Of Probability Distributions, Option Pricing, And Monte Carlo Simulations," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(03), pages 1-49, May.
    13. Pesenti, Silvana M. & Millossovich, Pietro & Tsanakas, Andreas, 2019. "Reverse sensitivity testing: What does it take to break the model?," European Journal of Operational Research, Elsevier, vol. 274(2), pages 654-670.
    14. Gianluca Fusai & Ioannis Kyriakou, 2016. "General Optimized Lower and Upper Bounds for Discrete and Continuous Arithmetic Asian Options," Mathematics of Operations Research, INFORMS, vol. 41(2), pages 531-559, May.
    15. Sergei Levendorskiĭ, 2022. "Operators and Boundary Problems in Finance, Economics and Insurance: Peculiarities, Efficient Methods and Outstanding Problems," Mathematics, MDPI, vol. 10(7), pages 1-36, March.
    16. Kyoung-Kuk Kim & Sojung Kim, 2016. "Simulation of Tempered Stable Lévy Bridges and Its Applications," Operations Research, INFORMS, vol. 64(2), pages 495-509, April.
    17. Koch, Erwan & Robert, Christian Y., 2022. "Stochastic derivative estimation for max-stable random fields," European Journal of Operational Research, Elsevier, vol. 302(2), pages 575-588.
    18. Erwan Koch & Christian Y. Robert, 2018. "Stochastic derivative estimation for max-stable random fields," Papers 1812.05893, arXiv.org, revised Nov 2020.
    19. Michele Azzone & Roberto Baviera, 2023. "A fast Monte Carlo scheme for additive processes and option pricing," Computational Management Science, Springer, vol. 20(1), pages 1-34, December.

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