Abstract

We investigate the problem of computing a nested expectation of the form P[E[X|Y] >= 0] = E[H(E[X|Y])] where H is the Heaviside function. This nested expectation appears, for example, when estimating the probability of a large loss from a financial portfolio. We present a method that combines the idea of using Multilevel Monte Carlo (MLMC) for nested expectations with the idea of adaptively selecting the number of samples in the approximation of the inner expectation, as proposed by (Broadie et al., 2011). We propose and analyse an algorithm that adaptively selects the number of inner samples on each MLMC level and prove that the resulting MLMC method with adaptive sampling has an order e^-2|log(e)|2 complexity to achieve a root mean-squared error e. The theoretical analysis is verified by numerical experiments on a simple model problem. Joint work with: Michael B. Giles (University of Oxford)