what is Moment Matching

bmanas · December 23rd, 2009, 2:29 am

I heard people say when there is no closed form analytical solution, one can use moment matching. I wanted to know how moment matching helps in finding solution to a modelling/pricing problem. Also , what is the maximum number of moments one should match.Any guidance/references would be greatly appreciated.thanks

manolom · December 23rd, 2009, 7:52 am

It is nothing else that finding a random variable -much more mathematically tractable, and that approximates the original one in the sense that the first moments of both coincide- as a proxy.

bmanas · December 23rd, 2009, 8:57 am

thanks. can you please explain it with an example.

manolom · December 23rd, 2009, 1:43 pm

For example, moment matching applied to asian options on arithmetic average, or applied to options on baskets.

bmanas · December 24th, 2009, 12:38 am

thanks a lot for such a clear example.

Aaron · December 24th, 2009, 3:45 pm

Moment matching is rarely a good approach in finance or statistics, and virtually never a good approach when matching more than two moments.