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54
A New Approach to Modeling the Dynamics of Implied Distributions: Theory and Evidence from the S&P 500 Options
 JOURNAL OF BANKING AND FINANCE
, 2002
"... This paper presents a new approach to modeling the dynamics of implied distributions. First, we obtain a parsimonious description of the dynamics of the S&P 500 implied cumulative distribution functions (CDFs) by applying Principal Components Analysis. Subsequently, we develop new arbitragefree Mon ..."
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Cited by 12 (1 self)
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This paper presents a new approach to modeling the dynamics of implied distributions. First, we obtain a parsimonious description of the dynamics of the S&P 500 implied cumulative distribution functions (CDFs) by applying Principal Components Analysis. Subsequently, we develop new arbitragefree MonteCarlo simulation methods that model the evolution of the whole distribution through time as a diffusion process. Our approach generalizes the conventional approaches of modeling only the Þrst two moments as diffusion processes, and it has important implications for ”smileconsistent” option pricing and for risk management. The outofsample performance within a ValueatRisk framework is examined.
RegimeSwitching in Foreign Exchange Rates: Evidence from . . .
 Journal of Econometrics
, 2000
"... This paper examines the ability of regimeswitching models to capture the dynamics of foreign exchange rates. First we test the ability of the models to fit foreign exchange rate data insample and forecast variance outofsample. A regimeswitching model with independent shifts in mean and variance ..."
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Cited by 11 (0 self)
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This paper examines the ability of regimeswitching models to capture the dynamics of foreign exchange rates. First we test the ability of the models to fit foreign exchange rate data insample and forecast variance outofsample. A regimeswitching model with independent shifts in mean and variance exhibits a closer fit and more accurate variance forecasts than a range of other models. Next we use exchangetraded currency options to determine whether market prices reflect regimeswitching information. We find that observed option prices are significantly different from their theoretical levels determined by a regimeswitching option valuation model and that a simulated trading strategy based on regimeswitching option valuation generates higher profits than standard singleregime alternatives. Overall, the results indicate that observed option prices do not fully reflect regimeswitching information. Last revised: May 8, 1998 1 REGIMESWITCHING IN FOREIGN EXCHANGE RATES: EVIDENCE ...
Equilibrium investment and asset prices under imperfect corporate control
 American Economic Review
"... We integrate a widely accepted version of the separation of ownership and controlJensen’s (1986) free cash flow theory into a dynamic equilibrium model and study the effect of imperfect corporate control on asset prices and investment. Aggregate free cash flow of the corporate sector is an importa ..."
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Cited by 8 (0 self)
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We integrate a widely accepted version of the separation of ownership and controlJensen’s (1986) free cash flow theory into a dynamic equilibrium model and study the effect of imperfect corporate control on asset prices and investment. Aggregate free cash flow of the corporate sector is an important state variable in explaining asset prices, investment, and the cyclical behavior of interest rates and the yield curve. The financial friction causes cashflow shocks to affect investment, and causes otherwise i.i.d. shocks to be transmitted from period to period. The shocks propagate through large firms and during booms.
MCMC estimation of multiscale stochastic volatility models
 In Handbook of Quantitative Finance and Risk
, 2009
"... In this paper we propose to use Monte Carlo Markov Chain methods to estimate the parameters of Stochastic Volatility Models with several factors varying at different time scales. The originality of our approach, in contrast with classical factor models is the identification of two factors driving un ..."
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Cited by 6 (3 self)
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In this paper we propose to use Monte Carlo Markov Chain methods to estimate the parameters of Stochastic Volatility Models with several factors varying at different time scales. The originality of our approach, in contrast with classical factor models is the identification of two factors driving univariate series at wellseparated time scales. This is tested with simulated data as well as foreign exchange data.
Pricing stock options under stochastic volatility and stochastic interest rates with efficient method . . .
, 1998
"... ..."
A comparison of qoptimal option prices in a stochastic volatility model with correlation. Oxford Financial Research Centre Preprint 2003MF02
, 2003
"... This paper investigates option prices in an incomplete stochastic volatility model with correlation. In a general setting, we prove an ordering result which says that prices for European options with convex payoffs are decreasing in the market price of volatility risk. As an example, and as our main ..."
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Cited by 5 (3 self)
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This paper investigates option prices in an incomplete stochastic volatility model with correlation. In a general setting, we prove an ordering result which says that prices for European options with convex payoffs are decreasing in the market price of volatility risk. As an example, and as our main motivation, we investigate option pricing under the class of qoptimal pricing measures. Using the ordering result, we prove comparison theorems between option prices under the minimal martingale, minimal entropy and varianceoptimal pricing measures. If the Sharpe ratio is deterministic, the comparison collapses to the well known result that option prices computed under these three pricing measures are the same. As a concrete example, we specialise to a variant of the Heston model for which the Sharpe ratio is increasing in volatility. For this example we are able to deduce option prices are decreasing in the parameter q. Numerical solution of the pricing pde corroborates the theory and shows the magnitude of the differences in option price due to varying q. Choice of q is shown to influence the level of the implied volatility smile for options of varying maturity. We would like to thank participants at the OxfordPrinceton Mathematical Finance Workshop,
The Importance of the Loss Function in Option Pricing
, 2001
"... Which loss function should be used when estimating and evaluating option pricing models? Many different functions have been suggested, but no standard has emerged. We do not promote a particular function, but instead emphasize that consistency in the choice of loss functions is crucial. First, for a ..."
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Cited by 4 (0 self)
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Which loss function should be used when estimating and evaluating option pricing models? Many different functions have been suggested, but no standard has emerged. We do not promote a particular function, but instead emphasize that consistency in the choice of loss functions is crucial. First, for any given model, the loss function used in parameter estimation and model evaluation should be identical, otherwise suboptimal parameter estimates will be obtained. Second, when comparing models, the estimation loss function should be identical across models, otherwise unfair comparisons will be made. We illustrate the importance of these issues in an application of the socalled Practitioner BlackScholes (PBS) model to S&P500 index options. We find reductions of over 50 percent in the root mean squared error of the PBS model when the estimation and evaluation loss functions are aligned. We also find that the PBS model outperforms a benchmark structural model when the estimation loss functions are identical across models, but otherwise not. The new PBS model with aligned loss functions thus represents a much tougher benchmark against which future structural models can be compared.
Index Option Pricing Models with Stochastic Volatility and Stochastic Interest Rates
, 2000
"... : This paper specifies a multivariate stochastic volatility (SV) model for the S&P500 index and spot interest rate processes. We first estimate the multivariate SV model via the efficient method of moments (EMM) technique based on observations of underlying state variables, and then investigate t ..."
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Cited by 3 (0 self)
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: This paper specifies a multivariate stochastic volatility (SV) model for the S&P500 index and spot interest rate processes. We first estimate the multivariate SV model via the efficient method of moments (EMM) technique based on observations of underlying state variables, and then investigate the respective effects of stochastic interest rates, stochastic volatility, and asymmetric S&P500 index returns on option prices. We compute option prices using both reprojected underlying historical volatilities and the implied risk premium of stochastic volatility to gauge each model's performance through direct comparison with observed market option prices on the index. Our major empirical findings are summarized as follows. First, while allowing for stochastic volatility can reduce the pricing errors and allowing for asymmetric volatility or "leverage effect" does help to explain the skewness of the volatility "smile", allowing for stochastic interest rates has minimal impact on o...
GARCH vs Stochastic Volatility: Option Procing and Risk Management
 Journal of Banking and Finance
, 2001
"... This paper examines the outofsample performance of two common extensions of the BlackScholes framework, namely a GARCH and a stochastic volatility option pricing model. The models are calibrated to intraday FTSE 100 option prices. We apply two sets of performance criteria, namely outofsample ..."
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Cited by 3 (0 self)
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This paper examines the outofsample performance of two common extensions of the BlackScholes framework, namely a GARCH and a stochastic volatility option pricing model. The models are calibrated to intraday FTSE 100 option prices. We apply two sets of performance criteria, namely outofsample valuation errors and ValueatRisk oriented measures. When we analyze the fit to observed prices, GARCH clearly dominates both stochastic volatility and the benchmark BlackScholes model.
A comparison of option prices under different pricing measures in a stochastic volatility model with correlation
, 2003
"... This paper investigates option prices in an incomplete stochastic volatility model with correlation. In a general setting, we prove an ordering result which says that prices for European options with convex payoffs are decreasing in the market price of volatility risk. As an example ..."
Abstract

Cited by 3 (0 self)
 Add to MetaCart
This paper investigates option prices in an incomplete stochastic volatility model with correlation. In a general setting, we prove an ordering result which says that prices for European options with convex payoffs are decreasing in the market price of volatility risk. As an example