Download presentation

Presentation is loading. Please wait.

Published byAlexandra Douty Modified over 2 years ago

1
Change of Time Method in Mathematical Finance Anatoliy Swishchuk Mathematical & Computational Finance Lab Department of Mathematics & Statistics University of Calgary, Calgary, Alberta, Canada CMS 2006 Summer Meeting Mathematical Finance Session Calgary, AB, Canada June 3-5, 2006

2
Outline Change of Time (CT): Definition and Examples Change of Time Method (CTM): Short History Black-Scholes by CTM (i.e., CTM for GBM) Explicit Option Pricing Formula (EOPF) for Mean-Reverting Model (MRM) by CTM Black-Scholes Formula as a Particular Case of EOPF for MRM Modeling and Pricing of Variance and Volatility Swaps by CTM

3
Change of Time: Definition and Examples Change of Time-change time from t to a non- negative process with non-decreasing sample paths Example 1 (Time-Changed Brownian Motion): M(t)=B(T(t)), B(t)-Brownian motion, T(t) is change of time Example 2 (Subordinator): X(t) and T(t)>0 are some processes, then X(T(t)) is subordinated to X(t); T(t) is change of time Example 3 (Standard Stochastic Volatility Model (SVM) ): M(t)=\int_0^t\sigma(s)dB(s), T(t)=[M(t)]=\int_0^t\sigma^2(s)ds. T(t)=[M(t)]=\int_0^t\sigma^2(s)ds.

4
Change of Time: Short History. I. Bochner (1949) -introduced the notion of change of time (CT) (time-changed Brownian motion) Bochner (1955) (‘Harmonic Analysis and the Theory of Probability’, UCLA Press, 176)-further development of CT

5
Change of Time: Short History. II. Feller (1966) -introduced subordinated processes X(T(t)) with Markov process X(t) and T(t) as a process with independent increments (i.e., Poisson process); T(t) was called randomized operational time Clark (1973)-first introduced Bochner’s (1949) time-changed Brownian motion into financial economics: he wrote down a model for the log- price M as M(t)=B(T(t)), where B(t) is Brownian motion, T(t) is time-change (B and T are independent)

6
Change of Time: Short History. III. Ikeda & Watanabe (1981)-introduced and studied CTM for the solution of Stochastic Differential Equations Carr, Geman, Madan & Yor (2003)-used subordinated processes to construct SV for Levy Processes (T(t)-business time)

7
Geometric Brownian Motion (Black-Scholes Formula by CTM)

8
Change of Time Method

9
Time-Changed BM is a Martingale

10
Option Pricing

11
European Call Option Pricing (Pay-Off Function)

12
European Call Option Pricing

13
Black-Scholes Formula

14
Mean-Reverting Model (Option Pricing Formula by CTM )

15
Solution of MRM by CTM

16
European Call Option for MRM.I.

17
European Call Option (Payoff Function)

18
Expression for y_0 for MRM

19
Expression for C_T C_T=BS(T)+A(T) ( Black-Scholes Part+Additional Term due to mean-reversion )

20
Expression for BS(T)

21
Expression for A(T)

22
European Call Option Price for MRM in Real World

23
European Call Option for MRM in Risk- Neutral World

24

25

26
Dependence of ES(t) on T (mean-reverting level L^*=2.569 )

27
Dependence of ES(t) on S_0 and T (mean-reverting level L^*=2.569)

28
Dependence of Variance of S(t) on S_0 and T

29
Dependence of Volatility of S(t) on S_0 and T

30
Dependence of C_T on T

31
Heston Model (Pricing Variance and Volatility Swaps by CTM)

32
Explicit Solution for CIR Process: CTM

33
Why Trade Volatility?

34
Variance Swap for Heston Model

35
Volatility Swap for Heston Model

36
How Does the Volatility Swap Work?

37

38
Pricing of Variance Swap for Heston Model

39
Pricing of Volatility Swap for Heston Model

40
Brockhaus and Long Results Brockhaus & Long (2000) obtained the same results for variance and volatility swaps for Heston model using another technique (analytical rather than probabilistic), including inverse Laplace transform

41
Statistics on Log Returns of S&P Canada Index (Jan 1997-Feb 2002)

42
Histograms of Log-Returns for S&P60 Canada Index

43
Convexity Adjustment

44
S&P60 Canada Index Volatility Swap

45
Conclusions CTM works for: Geometric Brownian motion (to price options in money markets) Mean-Reverting Model (to price options in energy markets) Heston Model (to price variance and volatility swaps) Much More: Covariance and Correlation Swaps

46
The End/Fin Thank You!/ Thank You!/ Merci Beaucoup!

Similar presentations

© 2017 SlidePlayer.com Inc.

All rights reserved.

Ads by Google