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16 - A real-life example: building a realistic Bayesian net

from Part V - Building Bayesian nets in practice

Published online by Cambridge University Press:  18 December 2013

Riccardo Rebonato
Affiliation:
PIMCO
Alexander Denev
Affiliation:
Royal Bank of Scotland
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Summary

In preparing for battle I have always found that plans are useless, but planning is indispensable. General Dwight D Eisenhower, 34th president of US 1953–1961 (1890–1969)

The purpose of this chapter

In this chapter we present a step-by-step construction of the Bayesian net associated with a reasonably realistic scenario. This is the scenario for which in Chapters 26–29 we will obtain and analyse in detail the allocation results, and for which we will carry out a detailed sensitivity analysis.

Rather than presenting a doctored and sanitized ‘authorized version’, we go through all the steps of the construction of the net, including the false starts, the errors and the hard choices that any real-life implementation inevitably entails. For this reason in this chapter elegance of presentation is not our main concern, and we prefer to show the construction in a warts-and-all manner. As the quote that opens this chapter alludes to, we find the effort put into the preparation phase of a Bayesian net invaluable, and the clarity of thought it stimulates useful, even if, much as General Eisenhower's battle plans, the events in our scenario will not ultimately unfold as we tried to model.

Step-by-step construction in a realistic case

Roots, leaves and transmission channels

Let us start from the following stress scenario, provisionally mapped onto the Bayesian net depicted in Figure 16.1.

Type
Chapter
Information
Portfolio Management under Stress
A Bayesian-Net Approach to Coherent Asset Allocation
, pp. 203 - 238
Publisher: Cambridge University Press
Print publication year: 2014

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