Generating realistic data is a challenge that is often encountered in model development, testing and validation. There are many relevant examples. In valuation modelling, we need market data such as interest rate curves and volatility surfaces. These objects have an intricate structure and strong constraints from non-arbitrage conditions. Hence, generating them randomly in a naive fashion is bound to fail. Random curves and surfaces could indeed expose issues with a model, but since such configurations are improbable to realize, the added value of a test like this is rather low.
Another scenario where generation is needed is the case of sparse data. When e.g. studying low default portfolio’s, by definition there is not a lot of data to train the models on. Hence, proper data generation techniques are extremely important.
One traditional approach, especially in the context of time series, is to perform a principal component analysis on a set of data samples (such as IR curves). Once the principal components are determined, we can then construct the distribution of the strength of every component. Generating a new sample then simply means that we sample from these distributions and reconstruct the data using the components. Such an approach works fine for data sets that are not too large. However, for big datasets, or in case the data does not have a time dimension, we need other techniques.
Generative Adversarial Networks or GANs (see Goodfellow I. et al) are a compelling technique to build extremely realistic data sets. The algorithm consists of two neural networks. A first network, the generator, creates candidates while the discriminator attempts to identify whether the candidate originated from the real dataset or if the generator created a synthetic sample. By repeating this procedure, the generator becomes more and more accurate in creating realistically looking candidates while the discriminator becomes better at identifying deviations from the real dataset. Once the system is trained, one can use the generator to create very realistic samples.
Apart from generating realistic datasets, there are many mode applications of GAN’s in finance. To end with one interesting use case, in this paper Hadad et al. use GAN’s to decompose stock price time series in a market and an idiosyncratic component.
Interested in learning more? Download here our white paper The Evolution of Model Risk Management.
Interested in learning more? Watch a demo of Chiron, our flagship product.