Computing tails of compound distributions using direct numerical integration

DOI10.21314/JCF.2009.193MaRDI QIDQ3400797zbMATH OpenOpenAlexFDO

Authors Xiaolin Luo, Pavel V. Shevchenko

Publication date 5 February 2010

Published in The Journal of Computational Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/0904.0830

zbMATH Keywords

direct numerical integrationDNIfast Fourier transformFFTMonte Carlovalue at riskVaR

Mathematics Subject Classification ID

Monte Carlo methods (65C05) Numerical integration (65D30) Numerical methods for discrete and fast Fourier transforms (65T50) Numerical methods (including Monte Carlo methods) (91G60)

Abstract: An efficient adaptive direct numerical integration (DNI) algorithm is developed for computing high quantiles and conditional Value at Risk (CVaR) of compound distributions using characteristic functions. A key innovation of the numerical scheme is an effective tail integration approximation that reduces the truncation errors significantly with little extra effort. High precision results of the 0.999 quantile and CVaR were obtained for compound losses with heavy tails and a very wide range of loss frequencies using the DNI, Fast Fourier Transform (FFT) and Monte Carlo (MC) methods. These results, particularly relevant to operational risk modelling, can serve as benchmarks for comparing different numerical methods. We found that the adaptive DNI can achieve high accuracy with relatively coarse grids. It is much faster than MC and competitive with FFT in computing high quantiles and CVaR of compound distributions in the case of moderate to high frequencies and heavy tails.

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Cited in

(3)

• Computation of Compound Distributions II: Discretization Errors and Richardson Extrapolation
• Theoretical sensitivity analysis for quantitative operational risk management
• A value-at-risk approach to optimisation of warranty policy

Describes a project that uses

Uses Software

• QUADPACK
• UNCMND
• pchip

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