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Affine representations of fractional processes with applications in mathematical finance
Authors:Philipp Harms  David Stefanovits
Affiliation:1. Department of Mathematical Stochastics, University of Freiburg, Germany;2. ETH Zurich, Switzerland
Abstract:Fractional processes have gained popularity in financial modeling due to the dependence structure of their increments and the roughness of their sample paths. The non-Markovianity of these processes gives, however, rise to conceptual and practical difficulties in computation and calibration. To address these issues, we show that a certain class of fractional processes can be represented as linear functionals of an infinite dimensional affine process. This can be derived from integral representations similar to those of Carmona, Coutin, Montseny, and Muravlev. We demonstrate by means of several examples that this allows one to construct tractable financial models with fractional features.
Keywords:60G22  60G15  60J25  91G30  Fractional process  Markovian representation  Affine process  Infinite-dimensional Markov process  Fractional interest rate model  Fractional volatility model
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