Results 1  10
of
58
TimeChanged Lévy Processes and Option Pricing
, 2002
"... As is well known, the classic BlackScholes option pricing model assumes that returns follow Brownian motion. It is widely recognized that return processes differ from this benchmark in at least three important ways. First, asset prices jump, leading to nonnormal return innovations. Second, return ..."
Abstract

Cited by 147 (21 self)
 Add to MetaCart
As is well known, the classic BlackScholes option pricing model assumes that returns follow Brownian motion. It is widely recognized that return processes differ from this benchmark in at least three important ways. First, asset prices jump, leading to nonnormal return innovations. Second, return volatilities vary stochastically over time. Third, returns and their volatilities are correlated, often negatively for equities. We propose that timechanged Lévy processes be used to simultaneously address these three facets of the underlying asset return process. We show that our framework encompasses almost all of the models proposed in the option pricing literature. Despite the generality of our approach, we show that it is straightforward to select and test a particular option pricing model through the use of characteristic function technology.
The Finite Moment Log Stable Process and Option Pricing
, 2002
"... We document a surprising pattern in market prices of S&P 500 index options. When implied volatilities are graphed against a standard measure of moneyness, the implied volatility smirk does not flatten out as maturity increases up to the observable horizon of two years. This behavior contrasts sh ..."
Abstract

Cited by 90 (12 self)
 Add to MetaCart
We document a surprising pattern in market prices of S&P 500 index options. When implied volatilities are graphed against a standard measure of moneyness, the implied volatility smirk does not flatten out as maturity increases up to the observable horizon of two years. This behavior contrasts sharply with the implications of many pricing models and with the asymptotic behavior implied by the central limit theorem (CLT). We develop a parsimonious model which deliberately violates the CLT assumptions and thus captures the observed behavior of the volatility smirk over the maturity horizon. Calibration exercises demonstrate its superior performance against several widely used alternatives.
Term structure dynamics in theory and reality
 Review of Financial Studies
, 2003
"... This paper is a critical survey of models designed for pricing fixed income securities and their associated term structures of market yields. Our primary focus is on the interplay between the theoretical specification of dynamic term structure models and their empirical fit to historical changes in ..."
Abstract

Cited by 85 (11 self)
 Add to MetaCart
This paper is a critical survey of models designed for pricing fixed income securities and their associated term structures of market yields. Our primary focus is on the interplay between the theoretical specification of dynamic term structure models and their empirical fit to historical changes in the shapes of yield curves. We begin by overviewing the dynamic term structure models that have been fit to treasury or swap yield curves and in which the risk factors follow diffusions, jumpdiffusion, or have “switching regimes. ” Then the goodnessoffits of these models are assessed relative to their abilities to: (i) match linear projections of changes in yields onto the slope of the yield curve; (ii) match the persistence of conditional volatilities, and the shapes of term structures of unconditional volatilities, of yields; and (iii) to reliably price caps, swaptions, and other fixedincome derivatives. For the case of defaultable securities we explore the relative fits to historical yield spreads. 1
Specification Analysis of Option Pricing Models Based on TimeChanged Lévy Processes
, 2003
"... We analyze the specifications of option pricing models based on timechanged Lévy processes. We classify option pricing models based on the structure of the jump component in the underlying return process, the source of stochastic volatility, and the specification of the volatility process itself. O ..."
Abstract

Cited by 48 (8 self)
 Add to MetaCart
We analyze the specifications of option pricing models based on timechanged Lévy processes. We classify option pricing models based on the structure of the jump component in the underlying return process, the source of stochastic volatility, and the specification of the volatility process itself. Our estimation of a variety of model specifications indicates that to better capture the behavior of the S&P 500 index options, we must incorporate a high frequency jump component in the return process and generate stochastic volatilities from two different sources, the jump component and the diffusion component.
Stochastic risk premiums, stochastic skewness in currency options, and stochastic discount factors in international economies
 Journal of Financial Economics
, 2007
"... We develop models of stochastic discount factors in international economies that produce stochastic risk premiums and stochastic skewness in currency options. We estimate the models using timeseries returns and option prices on three currency pairs that form a triangular relation. Estimation shows ..."
Abstract

Cited by 25 (2 self)
 Add to MetaCart
We develop models of stochastic discount factors in international economies that produce stochastic risk premiums and stochastic skewness in currency options. We estimate the models using timeseries returns and option prices on three currency pairs that form a triangular relation. Estimation shows that the average risk premium in Japan is larger than that in the US or the UK, the global risk premium is more persistent and volatile than the countryspecific risk premiums, and investors respond differently to different shocks. We also identify highfrequency jumps in each economy, but find that only downside jumps are priced. Finally, our analysis shows that the risk premiums are economically compatible with movements in stock and bond market fundamentals.
Term structure models and the zero bound: an empirical investigation of japanese yields, Working paper
, 2011
"... When Japanese shortterm bond yields were near their zero bound, yields on longterm bonds showed substantial fluctuation, and there was a strong positive relationship between the level of interest rates and yield volatilities/risk premia. We explore whether several families of dynamic term structure ..."
Abstract

Cited by 24 (0 self)
 Add to MetaCart
When Japanese shortterm bond yields were near their zero bound, yields on longterm bonds showed substantial fluctuation, and there was a strong positive relationship between the level of interest rates and yield volatilities/risk premia. We explore whether several families of dynamic term structure models that enforce a zero lower bound on short rates imply conditional distributions of Japanese bond yields consistent with these patterns. Multifactor “shadowrate ” and quadraticGaussian models, evaluated at their maximum likelihood estimates, capture many features of the data. Furthermore, modelimplied risk premiums track realized excess returns during extended periods of nearzero short rates. In contrast, the conditional distributions implied by nonnegative affine models do not match their sample counterparts, and standard Gaussian affine models generate implausibly large negative risk premiums.
Design and Estimation of Quadratic Term Structure Models
, 2001
"... We consider the design and estimation of quadratic term structure models. We start with a list of stylized facts on interest rates and interest rate derivatives, classified into three layers: (1) general statistical properties, (2) forecasting relations, and (3) conditional dynamics. We then investi ..."
Abstract

Cited by 20 (5 self)
 Add to MetaCart
We consider the design and estimation of quadratic term structure models. We start with a list of stylized facts on interest rates and interest rate derivatives, classified into three layers: (1) general statistical properties, (2) forecasting relations, and (3) conditional dynamics. We then investigate the implications of each layer of property on model design and strive to establish a mapping between evidence and model structures. We calibrate a twofactor model that approximates these three layers of properties well, and illustrate how the model can be applied to pricing interest rate derivatives.
Monetary Policy Shifts and the Term Structure,”NBER working paper 13448
, 2008
"... Interest rate risk; timevarying parameter model. The paper has benefited from discussions with Michael Johannes and Monika Piazzesi. We thank seminar participants at UT Austin, the Capital Group, and the Federal Reserve Board. We thank Rudy LooKung for excellent research assistance. Andrew Ang and ..."
Abstract

Cited by 17 (1 self)
 Add to MetaCart
Interest rate risk; timevarying parameter model. The paper has benefited from discussions with Michael Johannes and Monika Piazzesi. We thank seminar participants at UT Austin, the Capital Group, and the Federal Reserve Board. We thank Rudy LooKung for excellent research assistance. Andrew Ang and Jean Boivin acknowledge support from the NSF (SES0137145 and SES0518770).
LinearQuadratic JumpDiffusion Modeling with Application to Stochastic Volatility
, 2004
"... We aim at accommodating the existing affine jumpdiffusion and quadratic models under the same roof, namely the linearquadratic jumpdiffusion (LQJD) class. We give a complete characterization of the dynamics of this class of models by stating explicitly a list of structural constraints, and comput ..."
Abstract

Cited by 17 (0 self)
 Add to MetaCart
We aim at accommodating the existing affine jumpdiffusion and quadratic models under the same roof, namely the linearquadratic jumpdiffusion (LQJD) class. We give a complete characterization of the dynamics of this class of models by stating explicitly a list of structural constraints, and compute standard and extended transforms relevant to asset pricing. We show that the LQJD class can be embedded into the affine class through use of an augmented state vector, and further establish that a onetoone equivalence relationship holds between both classes in terms of transform analysis. An option pricing application to multifactor stochastic volatility models reveals that adding nonlinearity into the model would reduce pricing errors and yield parameter estimates that are more in line with sensible economic interpretation.
Design and Estimation of MultiCurrency Quadratic Models
 Review of Finance
"... Abstract. To simultaneously account for the properties of interestrate term structure and foreign exchange rates within one arbitragefree framework, we propose a class of multicurrency quadratic models (MCQM) with an (m + n) factor structure in the pricing kernel of each economy. The m factors mo ..."
Abstract

Cited by 16 (2 self)
 Add to MetaCart
Abstract. To simultaneously account for the properties of interestrate term structure and foreign exchange rates within one arbitragefree framework, we propose a class of multicurrency quadratic models (MCQM) with an (m + n) factor structure in the pricing kernel of each economy. The m factors model the term structure of interest rates. The n factors capture the portion of the exchange rate movement that is independent of the term structure. Our modeling framework represents the first in the literature that not only explicitly allows independent currency movement, but also guarantees internal consistency across all economies without imposing any artificial constraints on the exchange rate dynamics. We estimate a series of multicurrency quadratic models using U.S. and Japanese LIBOR and swap rates and the exchange rate between the two economies. Estimation shows that independent currency factors are essential in releasing the tension between the currency movement and the term structure of interest rates. JEL Classification: G12, G13, E43 1.