Static Replication of Forward-Start Claims and Realized Variance Swaps

Abstract

The goal of this work is to examine the static replication of path-dependent derivatives such as realized variance swaps, using more standard products such as forward-start binary (i.e. digital) double calls and puts. We first examine, following Carr and Madan (2002 Carr, P. and Madan, D. 2002. “Towards a theory of volatility trading”. In Volatility: New Estimation Techniques for Pricing Derivatives Edited by: Jarrow, R. A. 417–427. (London: Risk Publication). [Google Scholar]), the static replication of path-independent claims with continuous and discontinuous payoff functions. Subsequently, the static replication of forward-start claims with payoffs given by a bivariate function of finite variation is examined. We postulate that certain forward-start binary (or barrier) options are traded. The work concludes by an application of our general results to the static hedging of a realized variance swap with forward-start binary (or barrier) options.     

Comment on: A Note on the Discontinuity Problem in Heston's Stochastic Volatility Model

Abstract

Guo and Hung (2007 Guo, J.-H. and Hung, M.-W. 2007. A note on the discontinuity problem in Heston's stochastic volatility model. Applied Mathematical Finance, 14(4): 339–345. [Taylor & Francis Online] , [Google Scholar]) recently studied the complex logarithm present in the characteristic function of Heston's stochastic volatility model. They proposed an algorithm for the evaluation of the characteristic function that is claimed to preserve its continuity. We show their algorithm is correct, although their proof is not.     

Pricing Exotic Discrete Variance Swaps under the 3/2-Stochastic Volatility Models

Abstract

We consider pricing of various types of exotic discrete variance swaps, like the gamma swaps and corridor variance swaps, under the 3/2-stochastic volatility models (SVMs) with jumps in asset price. The class of SVMs that use a constant-elasticity-of-variance (CEV) process for the instantaneous variance exhibits good analytical tractability only when the CEV parameter takes just a few special values (namely 0, 1/2, 1 and 3/2). The popular Heston model corresponds to the choice of the CEV parameter to be 1/2. However, the stochastic volatility dynamics implied by the Heston model fails to capture some important empirical features of the market data. The choice of 3/2 for the CEV parameter in the SVM shows better agreement with empirical studies while it maintains a good level of analytical tractability. Using the partial integro-differential equation (PIDE) formulation, we manage to derive quasi-closed-form pricing formulas for the fair strike prices of various types of exotic discrete variance swaps with various weight processes and different return specifications under the 3/2-model. Pricing properties of these exotic discrete variance swaps with respect to various model parameters are explored.     

Pricing Equity Swaps in an Economy with Jumps

Abstract

Empirical evidence confirms that asset price processes exhibit jumps and that asset returns are not Gaussian. We provide a pricing model for equity swaps including quanto equity swaps for a non-Gaussian market. The market is driven by a general marked point process as well as by a standard multidimensional Wiener process. In order to obtain closed-form solutions of the swap values, we assume that all parameters in the asset price processes are deterministic, but possibly functions of time. We derive swap prices using martingale methods rather than replicating portfolios, and we show how to calculate the convexity correction term analytically. Our results are an extension of the results of Liao and Wang (2003 Liao, M. and Wang, M. 2003. Pricing models of equity swaps. The Journal of Futures Markets, 23(8): 751–772. [Crossref], [Web of Science ®] , [Google Scholar]; Pricing models of equity swaps, The Journal of Futures Markets, 23(8), pp. 751–772). The martingale method is the key that enables the extension.     

Assessing the Performance of Different Volatility Estimators: A Monte Carlo Analysis

Abstract

We test the performance of different volatility estimators that have recently been proposed in the literature and have been designed to deal with problems arising when ultra high-frequency data are employed: microstructure noise and price discontinuities. Our goal is to provide an extensive simulation analysis for different levels of noise and frequency of jumps to compare the performance of the proposed volatility estimators. We conclude that the maximum likelihood estimator filter (MLE-F), a two-step parametric volatility estimator proposed by Cartea and Karyampas (2011a Cartea, Á. and Karyampas, D. 2011a. The relationship between the volatility of returns and the number of jumps in financial markets, SSRN eLibrary, Working Paper Series, SSRN.  [Google Scholar]; The relationship between the volatility returns and the number of jumps in financial markets, SSRN eLibrary, Working Paper Series, SSRN), outperforms most of the well-known high-frequency volatility estimators when different assumptions about the path properties of stock dynamics are used.     

Option pricing in a conditional Bilateral Gamma model

We propose a conditional Bilateral Gamma model, in which the shape parameters of the Bilateral Gamma distribution have a Garch-like dynamics. After risk neutralization by means of a Bilateral Esscher transform, the model admits a recursive procedure for the computation of the characteristic function of the underlying at maturity, à la Heston and Nandi (Rev Financ Stud 13(3):562–585, 2000). We compare the calibration performance on SPX options with the models of Heston and Nandi (Rev Financ Stud 13(3):562–585, 2000), Christoffersen et al. (J Econom 131(1–2):253–284, 2006) and with a dynamic variance Gamma model introduced in Mercuri and Bellini (J Financ Decis Mak 7(1):37–51, 2011), obtaining promising results.     

Prices and Asymptotics for Discrete Variance Swaps

Abstract

We study the fair strike of a discrete variance swap for a general time-homogeneous stochastic volatility model. In the special cases of Heston, Hull–White and Schöbel–Zhu stochastic volatility models, we give simple explicit expressions (improving Broadie and Jain (2008a). The effect of jumps and discrete sampling on volatility and variance swaps. International Journal of Theoretical and Applied Finance, 11(8), 761–797) in the case of the Heston model). We give conditions on parameters under which the fair strike of a discrete variance swap is higher or lower than that of the continuous variance swap. The interest rate and the correlation between the underlying price and its volatility are key elements in this analysis. We derive asymptotics for the discrete variance swaps and compare our results with those of Broadie and Jain (2008a. The effect of jumps and discrete sampling on volatility and variance swaps. International Journal of Theoretical and Applied Finance, 11(8), 761–797), Jarrow et al. (2013. Discretely sampled variance and volatility swaps versus their continuous approximations. Finance and Stochastics, 17(2), 305–324) and Keller-Ressel and Griessler (2012. Convex order of discrete, continuous and predictable quadratic variation and applications to options on variance. Working paper. Retrieved from http://arxiv.org/abs/1103.2310).     

Numerical Studies on Asymptotics of European Option Under Multiscale Stochastic Volatility

Multiscale stochastic volatilities models relax the constant volatility assumption from Black-Scholes option pricing model. Such models can capture the smile and skew of volatilities and therefore describe more accurately the movements of the trading prices. Christoffersen et al. Manag Sci 55(2):1914–1932 (2009) presented a model where the underlying price is governed by two volatility components, one changing fast and another changing slowly. Chiarella and Ziveyi Appl Math Comput 224:283–310 (2013) transformed Christoffersen’s model and computed an approximate formula for pricing American options. They used Duhamel’s principle to derive an integral form solution of the boundary value problem associated to the option price. Using method of characteristics, Fourier and Laplace transforms, they obtained with good accuracy the American option prices. In a previous research of the authors (Canhanga et al. 2014), a particular case of Chiarella and Ziveyi Appl Math Comput 224:283–310 (2013) model is used for pricing of European options. The novelty of this earlier work is to present an asymptotic expansion for the option price. The present paper provides experimental and numerical studies on investigating the accuracy of the approximation formulae given by this asymptotic expansion. We present also a procedure for calibrating the parameters produced by our first-order asymptotic approximation formulae. Our approximated option prices will be compared to the approximation obtained by Chiarella and Ziveyi Appl Math Comput 224:283–310 (2013).     

A General Optimal Multiple Stopping Problem with an Application to Swing Options

In their paper, Carmona and Touzi [8 Carmona, R., and Touzi, N. 2008. Optimal multiple stopping and valuation of swing options. Mathematical Finance 18(2):239–268.[Crossref], [Web of Science ®] , [Google Scholar]] studied an optimal multiple stopping time problem in a market where the price process is continuous. In this article, we generalize their results when the price process is allowed to jump. Also, we generalize the problem associated to the valuation of swing options to the context of jump diffusion processes. We relate our problem to a sequence of ordinary stopping time problems. We characterize the value function of each ordinary stopping time problem as the unique viscosity solution of the associated Hamilton–Jacobi–Bellman variational inequality.     

Heston模型下的方差互换定价研究

通过实证分析论证了波动率具有均值回复性质的合理性.在Heston模型下,利用Ito积分推导出了方差互换在其存续期内任意时刻的价格与公平执行价格的定价公式.得到公平执行价格是波动率的平方的初始水平与长期均值水平的线性组合的性质,并利用该性质对Heston模型参数的敏感性进行了分析.     

Online pricing for bundles of multiple items

Given a seller with $k$ types of items, $m$ of each, a sequence of users $\{u_1, u_2,\ldots \}$ arrive one by one. Each user is single-minded, i.e., each user is interested only in a particular bundle of items. The seller must set the price and assign some amount of bundles to each user upon his/her arrival. Bundles can be sold fractionally. Each $u_i$ has his/her value function $v_i(\cdot )$ such that $v_i(x)$ is the highest unit price $u_i$ is willing to pay for $x$ bundles. The objective is to maximize the revenue of the seller by setting the price and amount of bundles for each user. In this paper, we first show that a lower bound of the competitive ratio for this problem is $\Omega (\log h+\log k)$ , where $h$ is the highest unit price to be paid among all users. We then give a deterministic online algorithm, Pricing, whose competitive ratio is $O(\sqrt{k}\cdot \log h\log k)$ . When $k=1$ the lower and upper bounds asymptotically match the optimal result $O(\log h)$ .     

A New Approach to Pricing Double-Barrier Options with Arbitrary Payoffs and Exponential Boundaries

Abstract

We consider in this article the arbitrage free pricing of double knock-out barrier options with payoffs that are arbitrary functions of the underlying asset, where we allow exponentially time-varying barrier levels in an otherwise standard Black–Scholes model. Our approach, reminiscent of the method of images of electromagnetics, considerably simplifies the derivation of analytical formulae for this class of exotics by reducing the pricing of any double-barrier problem to that of pricing a related European option. We illustrate the method by reproducing the well-known formulae of Kunitomo and Ikeda (1992 Kunitomo, N. and Ikeda, M. 1992. Pricing options with curved boundaries. Mathematical Finance, 2: 276–298.  [Google Scholar]) for the standard knock-out double-barrier call and put options. We give an explanation for the rapid rate of convergence of the doubly infinite sums for affine payoffs in the stock price, as encountered in the pricing of double-barrier call and put options first observed by Kunitomo and Ikeda (1992 Kunitomo, N. and Ikeda, M. 1992. Pricing options with curved boundaries. Mathematical Finance, 2: 276–298.  [Google Scholar]).     

Multistep Bayesian Strategy in Coin-Tossing Games and Its Application to Asset Trading Games in Continuous Time

We study multistep Bayesian betting strategies in coin-tossing games in the framework of game-theoretic probability of Shafer and Vovk [12 Shafer , G. , and Vovk , V. 2001 . Probability and Finance: It's Only a Game! Wiley , New York .[Crossref] , [Google Scholar]]. We show that by a countable mixture of these strategies, a gambler or an investor can exploit arbitrary patterns of deviations of nature's moves from independent Bernoulli trials. We then apply our scheme to asset trading games in continuous time and derive the exponential growth rate of the investor's capital when the variation exponent of the asset price path deviates from two.     

Gradient flow for the Boltzmann entropy and Cheeger’s energy on time-dependent metric measure spaces

We introduce notions of dynamic gradient flows on time-dependent metric spaces as well as on time-dependent Hilbert spaces. We prove existence of solutions for a class of time-dependent energy functionals in both settings. In particular, in the case when each underlying space satisfies a lower Ricci curvature bound in the sense of Lott, Sturm and Villani, we provide time-discrete approximations of the time-dependent heat flows introduced in Kopfer and Sturm (Heat flows on time-dependent metric measure spaces and super-Ricci flows, 2017. arXiv:1611.02570).     

A Wealth and Status-Based Model of Residential Segregation

We extend the classic “Schelling model” (1971 Schelling , T. C. (1971). Dynamic models of segregation. Journal of Mathematical Sociology , 1, 143–186.[Taylor &; Francis Online], [Web of Science ®] , [Google Scholar] 1978 Schelling , T. C. ( 1978 ). Micromotives and Macrobehavior , New York and London : W.W. Norton and Company . [Google Scholar]) to incorporate the wealth and status of agents and the desirability and affordability of residences. We analyze the effects of 1) the degree of the status-wealth correlation, and 2) the extent to which the wealth of residents shapes the affordability of residences, on levels of status and wealth segregation. Both factors generally exert a positive effect on both forms of segregation and interact to produce higher levels of segregation. The greater the correlation between status and wealth, the more the agents tend to segregate, either due to choice (for the wealthy and high status) or exclusion (for the poor and low status). We also find that housing price endogeneity is a precondition for status segregation.     

Large Deviations of the Threshold Estimator of Integrated (Co-)Volatility Vector in the Presence of Jumps

Recently considerable interest has been paid to the estimation problem of the realized volatility and covolatility by using high-frequency data of financial price processes in financial econometrics. Threshold estimation is one of the useful techniques in the inference for jump-type stochastic processes from discrete observations. In this paper, we adopt the threshold estimator introduced by Mancini (Scand Actuar J 1:42–52, 2004) where only the variations under a given threshold function are taken into account. The purpose of this work is to investigate large and moderate deviations for the threshold estimator of the integrated variance–covariance vector. This paper is an extension of the previous work in Djellout et al. (Stoch Process Appl 1–35, 2017), where the problem has been studied in the absence of a jump component. We will use the approximation lemma to prove large and moderate deviations results. As the reader can expect, we obtain the same results as in the case without jump.     

Maximal Regularity for Non-Autonomous Second Order Cauchy Problems

We consider non-autonomous wave equations $$\left\{\begin{array}{ll}\ddot{u}(t) + \mathcal{B}(t) \dot{u}(t) + \mathcal{A}(t)u(t) = f(t) \quad t{\text -}{\rm a.e.}\\ u(0) = u_{0},\, \dot{u}(0) = u_{1}.\\\end{array}\right.$$ where the operators ${\mathcal{A}(t)}$ and ${\mathcal{B}(t)}$ are associated with time-dependent sesquilinear forms ${\mathfrak{a}(t, ., .)}$ and ${\mathfrak{b}}$ defined on a Hilbert space H with the same domain V. The initial values satisfy ${u_0 \in V}$ and ${u_1 \in H}$ . We prove well-posedness and maximal regularity for the solution both in the spaces V′ and H. We apply the results to non-autonomous Robin-boundary conditions and also use maximal regularity to solve a quasilinear problem.     

Asymptotics for the Euler-Discretized Hull-White Stochastic Volatility Model

We consider the stochastic volatility model d S _t = σ _t S _t d W _t ,d σ _t = ω σ _t d Z _t , with (W _t ,Z _t ) uncorrelated standard Brownian motions. This is a special case of the Hull-White and the β=1 (log-normal) SABR model, which are widely used in financial practice. We study the properties of this model, discretized in time under several applications of the Euler-Maruyama scheme, and point out that the resulting model has certain properties which are different from those of the continuous time model. We study the asymptotics of the time-discretized model in the n→∞ limit of a very large number of time steps of size τ, at fixed \(\beta =\frac 12\omega ^{2}\tau n^{2}\) and \(\rho ={\sigma _{0}^{2}}\tau \), and derive three results: i) almost sure limits, ii) fluctuation results, and iii) explicit expressions for growth rates (Lyapunov exponents) of the positive integer moments of S _t . Under the Euler-Maruyama discretization for (S _t ,logσ _t ), the Lyapunov exponents have a phase transition, which appears in numerical simulations of the model as a numerical explosion of the asset price moments. We derive criteria for the appearance of these explosions.