easy · Quantitative Finance numerical
What is the primary function of Cholesky decomposition in Monte Carlo simulations for basket options?
- To calculate the eigenvalues and eigenvectors of the underlying asset return correlation matrix.
- To transform independent random draws into correlated draws that match a specified covariance matrix.
- To reduce the standard error of the Monte Carlo estimate using a dedicated variance reduction technique.
- To ensure that the covariance matrix used in the simulation is negative definite, not positive semi-definite.
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