Financial Modeling in a Fast Mean-Reverting Stochastic Volatility Environment
dc.contributor.author | Fouque, Jean-Pierre | en_US |
dc.contributor.author | Papanicolaou, George | en_US |
dc.contributor.author | Sircar, K. Ronnie | en_US |
dc.date.accessioned | 2006-09-08T20:40:33Z | |
dc.date.available | 2006-09-08T20:40:33Z | |
dc.date.issued | 1999-03 | en_US |
dc.identifier.citation | Fouque, Jean-Pierre; Papanicolaou, George; Sircar, K. Ronnie; (1999). "Financial Modeling in a Fast Mean-Reverting Stochastic Volatility Environment." Asia-Pacific Financial Markets 6(1): 37-48. <http://hdl.handle.net/2027.42/42745> | en_US |
dc.identifier.issn | 1387-2834 | en_US |
dc.identifier.issn | 1573-6946 | en_US |
dc.identifier.uri | https://hdl.handle.net/2027.42/42745 | |
dc.description.abstract | We present a derivative pricing and estimation methodology for a class of stochastic volatility models that exploits the observed 'bursty' or persistent nature of stock price volatility. Empirical analysis of high-frequency S&P 500 index data confirms that volatility reverts slowly to its mean in comparison to the tick-by- tick fluctuations of the index value, but it is fast mean- reverting when looked at over the time scale of a derivative contract (many months). This motivates an asymptotic analysis of the partial differential equation satisfied by derivative prices, utilizing the distinction between these time scales. The analysis yields pricing and implied volatility formulas, and the latter provides a simple procedure to 'fit the skew' from European index option prices. The theory identifies the important group parameters that are needed for the derivative pricing and hedging problem for European-style securities, namely the average volatility and the slope and intercept of the implied volatility line, plotted as a function of the log- moneyness-to-maturity-ratio. The results considerably simplify the estimation procedure. The remaining parameters, including the growth rate of the underlying, the correlation between asset price and volatility shocks, the rate of mean-reversion of the volatility and the market price of volatility risk are not needed for the asymptotic pricing formulas for European derivatives, and we derive the formula for a knock-out barrier option as an example. The extension to American and path-dependent contingent claims is the subject of future work. | en_US |
dc.format.extent | 79890 bytes | |
dc.format.extent | 3115 bytes | |
dc.format.mimetype | application/pdf | |
dc.format.mimetype | text/plain | |
dc.language.iso | en_US | |
dc.publisher | Kluwer Academic Publishers; Springer Science+Business Media | en_US |
dc.subject.other | Economics / Management Science | en_US |
dc.subject.other | Econometrics | en_US |
dc.subject.other | Economic Theory | en_US |
dc.subject.other | International Economics | en_US |
dc.subject.other | Finance /Banking | en_US |
dc.subject.other | Incomplete Markets | en_US |
dc.subject.other | Option Pricing | en_US |
dc.subject.other | Stochastic Equations | en_US |
dc.subject.other | Stochastic Volatility | en_US |
dc.title | Financial Modeling in a Fast Mean-Reverting Stochastic Volatility Environment | en_US |
dc.type | Article | en_US |
dc.subject.hlbsecondlevel | Economics | en_US |
dc.subject.hlbtoplevel | Business | en_US |
dc.description.peerreviewed | Peer Reviewed | en_US |
dc.contributor.affiliationum | Department of Mathematics, University of Michigan, Ann Arbor, MI, 48109-1109 | en_US |
dc.contributor.affiliationother | Department of Mathematics, North Carolina State University, Raleigh, NC, 27695-8205 | en_US |
dc.contributor.affiliationother | Department of Mathematics, Stanford University, Stanford, CA, 94305 | en_US |
dc.contributor.affiliationumcampus | Ann Arbor | en_US |
dc.description.bitstreamurl | http://deepblue.lib.umich.edu/bitstream/2027.42/42745/1/10690_2004_Article_200681.pdf | en_US |
dc.identifier.doi | http://dx.doi.org/10.1023/A:1010010626460 | en_US |
dc.identifier.source | Asia-Pacific Financial Markets | en_US |
dc.owningcollname | Interdisciplinary and Peer-Reviewed |
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