Setting up a Multistage Stochastic Program
Having proper risk factor models implemented, the next step is to develop a replicating portfolio methodology that defines the objective function and the constraints of the optimization procedure. Once this is done, a scenario tree will be generated, which predefines the stochastic factors of the risk factor models. Subsequently, future paths of the risk factors can be easily calculated, taking the stochastic factors from the scenario tree as input. To make the whole model framework computationally tractable, a certain complexity reduction technique will be applied to the MSP or more precisely to the scenario generation procedure.
KeywordsScenario Tree Sharpe Ratio Multivariate Normal Distribution Investment Policy Stochastic Factor
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