Perpetual Options on Multiple Underlyings

Abstract

We study three classes of perpetual option with multiple uncertainties and American-style exercise boundaries, using a partial differential equation-based approach. A combination of accurate numerical techniques and asymptotic analyses is implemented, with each approach informing and confirming the other. The first two examples we study are a put basket option and a call basket option, both involving two stochastic underlying assets, whilst the third is a (novel) class of real option linked to stochastic demand and costs (the details of the modelling for this are described in the paper). The Appendix addresses the issue of pricing American-style perpetual options involving (just) one stochastic underlying, but in which the volatility is also modelled stochastically, using the Heston (1993) framework.     

Solutions of the generalized Lennard-Jones system

In this paper, we study solution structures of the following generalized Lennard-Jones system in R~n,x=(-α/|x|~(α+2)+β/|x|~(β+2))x,with 0 α β. Considering periodic solutions with zero angular momentum, we prove that the corresponding problem degenerates to 1-dimensional and possesses infinitely many periodic solutions which must be oscillating line solutions or constant solutions. Considering solutions with non-zero angular momentum, we compute Morse indices of the circular solutions first, and then apply the mountain pass theorem to show the existence of non-circular solutions with non-zero topological degrees. We further prove that besides circular solutions the system possesses in fact countably many periodic solutions with arbitrarily large topological degree, infinitely many quasi-periodic solutions, and infinitely many asymptotic solutions.     

Extra regularity for parabolic equations with drift terms

We consider a parabolic equation with a drift term u+bu–u_t=0. Under some natural conditions on the vector valued function b, we prove that solutions possess extra regularity and better qualitative behavior than those provided by standard theory. For example, we show that the fundamental solution has global Gaussian upper bound even for some b with a large singularity in the form of c/|x|. We also show that bounded solutions are Hölder continuous when |b|² is just form bounded and divergence free, a case where not even continuity is expected. A Liouville type theorem is also proven.     

Dynamics of Bianchi Type I Solutions of the Einstein Equations with Anisotropic Matter

We analyze the global dynamics of Bianchi type I solutions of the Einstein equations with anisotropic matter. The matter model is not specified explicitly but only through a set of mild and physically motivated assumptions; thereby our analysis covers matter models as different from each other as, e.g., collisionless matter, elastic matter and magnetic fields. The main result we prove is the existence of an ‘anisotropy classification’ for the asymptotic behaviour of Bianchi type I cosmologies. The type of asymptotic behaviour of generic solutions is determined by one single parameter that describes certain properties of the anisotropic matter model under extreme conditions. The anisotropy classification comprises the following types. The convergent type A₊: Each solution converges to a Kasner solution as the singularity is approached and each Kasner solution is a possible past asymptotic state. The convergent types B₊ and C₊: Each solution converges to a Kasner solution as the singularity is approached; however, the set of Kasner solutions that are possible past asymptotic states is restricted. The oscillatory type D₊: Each solution oscillates between different Kasner solutions as the singularity is approached. Furthermore, we investigate non-generic asymptotic behaviour and the future asymptotic behaviour of solutions. Submitted: October 28, 2008.; Accepted: January 26, 2009.     

Expanding solitons with non-negative curvature operator coming out of cones

We consider Ricci flow of complete Riemannian manifolds which have bounded non-negative curvature operator, non-zero asymptotic volume ratio and no boundary. We prove scale invariant estimates for these solutions. Using these estimates, we show that there is a limit solution, obtained by scaling down this solution at a fixed point in space. This limit solution is an expanding soliton coming out of the asymptotic cone at infinity.     

Bonds and Options in Exponentially Affine Bond Models

Abstract

In this article we apply the Flesaker–Hughston approach to invert the yield curve and to price various options by letting the randomness in the economy be driven by a process closely related to the short rate, called the abstract short rate. This process is a pure deterministic translation of the short rate itself, and we use the deterministic shift to calibrate the models to the initial yield curve. We show that we can solve for the shift needed in closed form by transforming the problem to a new probability measure. Furthermore, when the abstract short rate follows a Cox–Ingersoll–Ross (CIR) process we compute bond option and swaption prices in closed form. We also propose a short-rate specification under the risk-neutral measure that allows the yield curve to be inverted and is consistent with the CIR dynamics for the abstract short rate, thus giving rise to closed form bond option and swaption prices.     

The Navier–Stokes problem modified by an absorption term

It is well known that for the classical Navier–Stokes problem the best one can obtain is some decays in time of power type. With this in mind, we consider in this work, the classical Navier–Stokes problem modified by introducing, in the momentum equation, the absorption term |u|^σ?2 u, where σ > 1. For the obtained problem, we prove the existence of weak solutions for any dimension N ≥ 2 and its uniqueness for N = 2. Then we prove that, for zero body forces, the weak solutions extinct in a finite time if 1 < σ < 2 and exponentially decay in time if σ = 2. In the special case of a suitable force field which vanishes at some instant, we prove that the weak solutions extinct at the same instant provided 1 < σ < 2. We also prove that for non-zero body forces decaying at a power-time rate, the solutions decay at analogous power-time rates if σ > 2. Finally, we prove that for a general non-zero body force, the weak solutions exponentially decay in time for any σ > 1.     

Carathéodory approximate solutions for a class of perturbed stochastic differential equations with reflecting boundary

Abstract

In this work, we study the Carathéodory approximate solution for a class of one-dimensional perturbed stochastic differential equations with reflecting boundary (PSDERB). Based on the Carathéodory approximation procedure, we prove that PSDERB have a unique solution and show that the Carathéodory approximate solution converges to the solution of PSDERB whose both drift and diffusion coefficients are non-Lipschitz. After that, we establish an explicit rate of convergence in the case of PSDERB with Lipschitz coefficients.     

Closed-Form Pricing of Two-Asset Barrier Options with Stochastic Covariance

Abstract

Single and double barrier options on more than one underlying with stochastic volatility are usually priced via Monte Carlo simulation due to the non-existence of closed-form solutions for their value. In this paper, for a special dependence structure, the prices of some two-asset barrier derivatives, like double-digital options and correlation options can be derived analytically using generalized Fourier transforms and some conditions on the characteristic functions. We study the influence of the various parameters on these prices and show that these formulas can be easily and quickly computed. We also extend our approach to further allow for a random correlation structure.     

Computing the Volume of n-Dimensional Copulas

Abstract

A problem that is very relevant in applications of copula functions to finance is the computation of the survival copula, which is applied to enforce multivariate put–call parity. This may be very complex for large dimensions. The problem is a special case of the more general problem of volume computation in high-dimensional copulas. We provide an algorithm for the exact computation of the volume of copula functions in cases where the copula function is computable in closed form. We apply the algorithm to the problem of computing the survival of a copula function in the pricing problem of a multivariate digital option, and we provide evidence that this is feasible for baskets of up to 20 underlying assets, with acceptable CPU time performance.     

Solving a partial differential equation associated with the pricing of power options with time‐dependent parameters

Previous analysis and research on the power option – one of the exotic options – have focused on the interest rate of the stock and its volatility as constant parameters throughout the run of execution. In this paper, we attempt to extend these results to the more practical and realistic case of when these parameters are time dependent. By making no ansatz or relying on ad hoc methods, we are able to achieve this via an algorithmic method – the Lie group approach – leading to exact solutions for the power option problem. Copyright © 2014 John Wiley & Sons, Ltd.     

Some results on b-AM-compact operators

We show that for positive operator B : E → E on Banach lattices, if there exists a positive operator S : E → E such that:1.SB ≤ BS;2.S is quasinilpotent at some x₀ > 0; 3.S dominates a non-zero b-AM-compact operator, then B has a non-trivial closed invariant subspace. Also, we prove that for two commuting non-zero positive operators on Banach lattices, if one of them is quasinilpotent at a non-zero positive vector and the other dominates a non-zero b-AM-compact operator, then both of them have a common non-trivial closed invariant ideal. Then we introduce the class of b-AM-compact-friendly operators and show that a non-zero positive b-AM- compact-friendly operator which is quasinilpotent at some x₀ > 0 has a non-trivial closed invariant ideal.     

Target pattern and spiral solutions to reaction-diffusion equations with more than one space dimension

We prove the existence of homogeneous target pattern and spiral solutions to equations of the form

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; the spatial dimension is greater than one. As in the one-dimensional case, such solutions exist for discrete values of the asymptotic wave number (or equivalently, the frequency of oscillation of the entire solution). For target patterns, we construct solutions for a sequence of frequencies. For spirals, we construct only the “lowest mode” solution.     

Random attractors for stochastic differential equations driven by two-sided Lévy processes

Abstract

In this paper, the asymptotic behavior of solutions for a nonlinear Marcus stochastic differential equation with multiplicative two-sided Lévy noise is studied. We plan to consider this equation as a random dynamical system. Thus, we have to interpret a Lévy noise as a two-sided metric dynamical system. For that, we have to introduce some fundamental properties of such a noise. So far most studies have only discussed two-sided Lévy processes which are defined by combining two-independent Lévy processes. In this paper, we use another definition of two-sided Lévy process by expanding the probability space. Having this metric dynamical system we will show that the Marcus stochastic differential equation with a particular drift coefficient and multiplicative noise generates a random dynamical system which has a random attractor.     

Properties of solutions of the Tricomi problem for the Lavrent’ev-Bitsadze equation at corner points

We consider the Tricomi problem for the Lavrent’ev-Bitsadze equation for the case in which the elliptic part of the boundary is part of a circle. For the homogeneous equation, we introduce a new class of solutions that are not continuous at the corner points of the domain and construct nontrivial solutions in this class in closed form. For the inhomogeneous equation, we introduce the notion of an n-regular solution and prove a criterion for the existence of such a solution.     

American Options in the Heston Model with Stochastic Interest Rate and Its Generalizations

Abstract

We consider the Heston model with the stochastic interest rate of Cox–Ingersoll–Ross (CIR) type and more general models with stochastic volatility and interest rates depending on two CIR-factors; the price, volatility and interest rate may correlate. Time-derivative and infinitesimal generator of the process for factors that determine the dynamics of the interest rate and/or volatility are discretized. The result is a sequence of embedded perpetual options arising in the time discretization of a Markov-modulated Lévy model. Options in this sequence are solved using an iteration method based on the Wiener–Hopf factorization. Typical shapes of the early exercise boundary are shown, and good agreement of option prices with prices calculated with the Longstaff–Schwartz method and Medvedev–Scaillet asymptotic method is demonstrated.     

The British Put Option

Abstract

We present a new put option where the holder enjoys the early exercise feature of American options whereupon his payoff (deliverable immediately) is the ‘best prediction’ of the European payoff under the hypothesis that the true drift of the stock price equals a contract drift. Inherent in this is a protection feature which is key to the British put option. Should the option holder believe the true drift of the stock price to be unfavourable (based upon the observed price movements) he can substitute the true drift with the contract drift and minimize his losses. The practical implications of this protection feature are most remarkable as not only can the option holder exercise at or above the strike price to a substantial reimbursement of the original option price (covering the ability to sell in a liquid option market completely endogenously) but also when the stock price movements are favourable he will generally receive higher returns at a lesser price. We derive a closed form expression for the arbitrage-free price in terms of the rational exercise boundary and show that the rational exercise boundary itself can be characterized as the unique solution to a nonlinear integral equation. Using these results we perform a financial analysis of the British put option that leads to the conclusions above and shows that with the contract drift properly selected the British put option becomes a very attractive alternative to the classic American put.     

Exact asymptotics in eigenproblems for fractional Brownian covariance operators

Many results in the theory of Gaussian processes rely on the eigenstructure of the covariance operator. However, eigenproblems are notoriously hard to solve explicitly and closed form solutions are known only in a limited number of cases. In this paper we set up a framework for the spectral analysis of the fractional type covariance operators, corresponding to an important family of processes, which includes the fractional Brownian motion and its noise. We obtain accurate asymptotic approximations for the eigenvalues and the eigenfunctions. Our results provide a key to several problems, whose solution is long known in the standard Brownian case, but was missing in the more general fractional setting. This includes computation of the exact limits of $L^2$-small ball probabilities and asymptotic analysis of singularly perturbed integral equations, arising in mathematical physics and applied probability.     

A scaled version of the double-mean-reverting model for VIX derivatives

As the Heston model is not consistent with VIX data in real market well enough, alternative stochastic volatility models including the double-mean-reverting model of Gatheral (in: Bachelier Congress, 2008) have been developed to overcome its limitation. The double-mean-reverting model is a three factor model successfully reflecting the empirical dynamics of the variance but there is no closed form solution for VIX derivatives and SPX options and thus calibration using conventional techniques may be slow. In this paper, we propose a fast mean-reverting version of the double-mean-reverting model. We obtain a closed form approximation for VIX derivatives and show how it is effective by comparing it with the Heston model and the double-mean-reverting model.     

New approach and analysis of the generalized constant elasticity of variance model

Generally, it is well known that the constant elasticity of variance (CEV) model fails to capture the empirical results verifying that the implied volatility of equity options displays smile and skew curves at the same time. In this study, to overcome the limitation of the CEV model, we introduce a new model, which is a generalization of the CEV model, and show that it can capture the smile and skew effects of implied volatility. Using an asymptotic analysis for two small parameters that determine the volatility shape, we obtain approximated solutions for option prices in the extended model. In addition, we demonstrate the stability of the solution for the expansion of the option price. Furthermore, we show the convergence rate of the solutions in Monte-Carlo simulation and compare our model with the CEV, Heston, and other extended stochastic volatility models to verify its flexibility and efficiency compared with these other models when fitting option data from the S&P 500 index.