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Formulation and solution strategies for nonparametric nonlinear stochastic programs, with an application in finance

Fabian Bastin(bastin***at***iro.umontreal.ca)
Cinzia Cirillo(ccirillo***at***umd.edu)
Philippe Toint(philippe.toint***at***fundp.ac.be)

Abstract: We consider a class of stochastic programming models where the uncertainty is classically represented using parametric distributions families. The parameters are then usually estimated together with the optimal value of the problem. However, misspecification of the underlying random variables often leads to irrealistic results when little is known about their true distributions. We propose to overcome this difficulty by introducing a nonparametric approach where we replace the estimation of the distribution parameters by that of cumulative distribution functions (CDF). A practical algorithm is described which achieves this goal by using a monotonic spline representation of the inverse marginal CDF's and a projection-based trust-region globalization. Applications of the new algorithm to discrete choice theory are finally discussed, both with simulated data and in the context of a practical financial application related to interventions of the Bank of Japan in the foreign exchange market.

Keywords: stochastic optimization, nonparametric distributions, trust-region methods, foreign exchange market

Category 1: Stochastic Programming

Category 2: Applications -- OR and Management Sciences (Finance and Economics )

Category 3: Nonlinear Optimization

Citation: @techreport{BastCiriToin07b, author = {F. Bastin and C. Cirillo and Ph. L. Toint}, title = {Formulation and solution strategies for nonparametric nonlinear stochastic programs, with an application in finance}, institution = {Department of Mathematics, University of NAmur - FUNDP}, address = {Namur, Belgium}, number = {07/16}, year = 2007}

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Entry Submitted: 01/04/2008
Entry Accepted: 01/04/2008
Entry Last Modified: 01/04/2008

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