Pricing model of interest rate swap with a bilateral default risk

Under the foundation of Duffie & Huang (1996) [7], this paper integrates the reduced form model and the structure model for a default risk measure, giving rise to a new pricing model of interest rate swap with a bilateral default risk. This model avoids the shortcomings of ignoring the dynamic movements of the firm’s assets of the reduced form model but adds only a little complexity and simplifies the pricing formula significantly when compared with Li (1998) [10]. With the help of the Crank-Nicholson difference method, we give the numerical solutions of the new model to study the default risk effects on the swap rate. We find that for a one year interest rate swap with the coupon paid per quarter, the variance of the default fixed rate payer decreases from 0.1 to 0.01 only causing about a 1.35%’s increase in the swap rate. This is consistent with previous results.     

Pricing and hedging derivative securities in markets with uncertain volatilities

We present a model for pricing and hedging derivative securities and option portfolios in an environment where the volatility is not known precisely, but is assumed instead to lie between two extreme values σ_minand σ_max. These bounds could be inferred from extreme values of the implied volatilities of liquid options, or from high-low peaks in historical stock- or option-implied volatilities. They can be viewed as defining a confidence interval for future volatility values. We show that the extremal non-arbitrageable prices for the derivative asset which arise as the volatility paths vary in such a band can be described by a non-linear PDE, which we call the Black-Scholes-Barenblatt equation. In this equation, the ‘pricing’ volatility is selected dynamically from the two extreme values, σ_min, σ_max, according to the convexity of the value-function. A simple algorithm for solving the equation by finite-differencing or a trinomial tree is presented. We show that this model captures the importance of diversification in managing derivatives positions. It can be used systematically to construct efficient hedges using other derivatives in conjunction with the underlying asset.     

A combinatorial bijection between linear extensions of equivalent orders

Let P and Q be (partially) ordered sets with the same comparability graph. A bijection is constructed between the sets of linear extensions of P and Q such that the number of setups is preserved. This yields a common generalization of the comparability invariance of order dimension, setup number and number of linear extensions.     

Pricing early exercise contracts in incomplete markets

We present a utility-based methodology for the valuation of early exercise contracts in incomplete markets. Incompleteness stems from nontraded assets on which the contracts are written. This methodology takes into account the individuals attitude towards risk and yields nonlinear pricing rules. The early exercise indifference prices solve a quasilinear variational inequality with an obstacle term. They are also shown to satisfy an optimal stopping problem with criterion given by their European indifference price counterpart. A class of numerical schemes are developed for the variational inequalities and a general approach for solving numerically nonlinear equations arising in incomplete markets is discussed.Accepted: May 2003, AMS Classification: 93E20, 60G40, 60J75The second author acknowledges partial support from NSF Grants DMS 0102909 and DMS 0091946.     

Pricing and hedging of American contingent claims in incomplete markets

0.IntroductionandSummaryThecelebratedpapersof[2]and[3],pavedthewayforpricingoptionsonstocks,onthebasisofthefollowingprinciple:inacompletemarket(suchastheoneinSection1.5),everycontingentclaimcanbeattainedexactlybyinvestinginthemarketandstartingwithala...     

Pricing policy in dynamic markets and a generalization of the Ramsey rule

Pricing policy in a regulated monopoly industry is usually based on maximizing welfare or some other measure of utility level of return on investment. Previously, the Ramsey pricing policy which states that the percentage deviation of quasi-optimal price from marginal cost for each product must be inversely proportional to its price elasticity of demand, has been developed for a static market. The Ramsey framework assumes instantaneous demand response to price changes; empirical evidence suggests demand changes occur dynamically through time.In this paper an optimum pricing rule for a profit maximizing firm based on a general time varying demand model in a dynamic market is obtained assuming a single price change at the beginning of the planning period. A dynamic market equivalent of the well known inverse elasticity law of the static market is developed. Defining the concept of average price elasticity for dynamic markets we show that the inverse elasticity law of static markets takes an inequality form in dynamic markets. For demand functions which decrease, increase or are constant with time the optimum price markups are greater than, less than, or equal to the inverse of the average price elasticity, respectively.The results are then generalized to the case of a constrained welfare maximizing firm. This leads to the development of a dynamic market generalization of the well known Ramsey pricing rule. A simple rule for making quantitative arguments about the relative size of the optimum price in static and dynamic markets is also derived.This work was completed when the author was with Bell Laboratories, USA.     

Interval orders and circle orders

A finite poset is an interval order if its point can be mapped into real intervals so that x in the poset precisely when x's interval lies wholly to the left of y's; the poset is a circle order if its points can be mapped into circular disks in the plane so that x precisely when x's circular disk is properly included in y's. This note proves that every finite interval order is a circle order.     

Circle orders and angle orders

A poset is a circle order if its points can be mapped into circular disks in the plane so that x in the poset precisely when x's circular disk is properly included in y's; the poset is an angle order if its points can be mapped into unbounded angular regions that preserve < by proper inclusion. It is well known that many finite angle orders are not circle orders, but has been open as to whether every finite circle order is an angle order. This paper proves that there are finite circle orders that are not angle orders.     

On constructing total orders and solving vector optimization problems with total orders

In this paper, we introduce a construction method of total ordering cone on \mathbbRⁿ{\mathbb{R}^n} . It is shown that any total ordering cone on \mathbbRⁿ{\mathbb{R}^n} is isomorphic to the cone \mathbbRⁿ_lex{\mathbb{R}^n_{lex}} . Existence of a total ordering cone that contain given cone with a compact base is shown. By using this cone, a solving method of vector and set valued optimization problems is presented.     

An integrable semi-discrete equation and combinatorial numbers with their combinatorial interpretations

A Hankel type determinant solution for an integrable semi-discrete equation is presented. As an application, the relations between the solution and combinatorial numbers are discussed, which lead to new combinatorial numbers. The so-called Motzkin-like numbers are obtained, and the corresponding combinatorial interpretation is given. Additionally, it is also shown that some lattice paths have connections with the special solution.     

Enhancing credit default swap valuation with meshfree methods

In this paper, we apply the meshfree radial basis function (RBF) interpolation to numerically approximate zero-coupon bond prices and survival probabilities in order to price credit default swap (CDS) contracts. We assume that the interest rate follows a Cox-Ingersoll-Ross process while the default intensity is described by the Exponential-Vasicek model. Several numerical experiments are conducted to evaluate the approximations by the RBF interpolation for one- and two-factor models. The results are compared with those estimated by the finite difference method (FDM). We find that the RBF interpolation achieves more accurate and computationally efficient results than the FDM. Our results also suggest that the correlation between factors does not have a significant impact on CDS spreads.     

Barndorff-Nielsen and Shephard model: oil hedging with variance swap and option

In this paper the Barndorff-Nielsen and Shephard (BN-S) model is implemented to find an optimal hedging strategy for the oil commodity from the Bakken, a new region of oil extraction that is benefiting from fracking technology. The model is analyzed in connection to the quadratic hedging problem and some related analytical results are developed. The results indicate that oil can be optimally hedged with the use of a combination of options and variance swaps. Theoretical results related to the variance process are established and implemented for the analysis of the variance swap. In this paper we also determined the optimal amount of the underlying oil commodity that has to be held for minimizing the hedging error. The model and analysis are used to numerically analyze hedging decisions for managing price risk in Bakken oil commodities. From the numerical results, a number of important features of the usefulness of the Barndorff-Nielsen and Shephard model are illustrated.

     

Quaternion orders with good divisibility

We examine quaternion orders with the complete factorization property. It is proved that all the indefinite quaternion orders have this property and that there is only a finite number of nonisomorphic definite quaternion orders with this property. The relation of this property to the properties of spinor genera of norm forms is established.Translated from Zapiski Nauchnykh Seminarov Leningradskogo Otdeleniya Matematicheskogo Instituta im. V. A. Steklova AN SSSR, Vol. 151, pp. 78–94, 1986.     

Circle orders,N-gon orders and the crossing number

Let ={P ₁,...,P _m } be a family of sets. A partial order P(, <) on is naturally defined by the condition P _i <P _j iff P _i is contained in P _j . When the elements of are disks (i.e. circles together with their interiors), P(, <) is called a circle order; if the elements of are n-polygons, P(, <) is called an n-gon order. In this paper we study circle orders and n-gon orders. The crossing number of a partial order introduced in [5] is studied here. We show that for every n, there are partial orders with crossing number n. We prove next that the crossing number of circle orders is at most 2 and that the crossing number of n-gon orders is at most 2n. We then produce for every n4 partial orders of dimension n which are not circle orders. Also for every n>3, we prove that there are partial orders of dimension 2n+2 which are not n-gon orders. Finally, we prove that every partial order of dimension 2n is an n-gon order.This research was supported under Natural Sciences and Engineering Research Council of Canada (NSERC Canada) grant numbers A2507 and A0977.     

Farthest-point queries with geometric and combinatorial constraints

In this paper we discuss farthest-point problems in which a set or sequence S of n points in the plane is given in advance and can be preprocessed to answer various queries efficiently. First, we give a data structure that can be used to compute the point farthest from a query line segment in O(log²n) time. Our data structure needs O(nlogn) space and preprocessing time. To the best of our knowledge no solution to this problem has been suggested yet. Second, we show how to use this data structure to obtain an output-sensitive query-based algorithm for polygonal path simplification. Both results are based on a series of data structures for fundamental farthest-point queries that can be reduced to each other.     

The swap conjecture of tennant and turner

We argue against the conjecture which says that any two finite generating sets for G of the same cardinality are swap equivalent. The latter means that one is changed to another by a finite sequence of generating sets such that all the neighboring sets differ only in a single entry. Namely, it is proved that a free metabelian group of rank 3 has non swap equivalent bases.Translated fromAlgebra i Logika, Vol. 34, No. 4, pp. 448–463, July-August, 1995.Supported by the Russian Foundation for Fundamental Research.