## Affine processes and applications in finance (2003)

Venue: | Annals of Applied Probability |

Citations: | 38 - 5 self |

### BibTeX

@ARTICLE{Duffie03affineprocesses,

author = {D. Duffie and D. Filipović and W. Schachermayer},

title = {Affine processes and applications in finance},

journal = {Annals of Applied Probability},

year = {2003},

volume = {13},

pages = {984--1053}

}

### Years of Citing Articles

### OpenURL

### Abstract

Abstract. We provide the definition and a complete characterization of regular affine processes. This type of process unifies the concepts of continuousstate branching processes with immigration and Ornstein-Uhlenbeck type processes. We show, and provide foundations for, a wide range of financial applications for regular affine processes.

### Citations

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Citation Context ...ton [56] approach to option pricing, building on earlier work of Stein and Stein [88] that did not exploit the properties of affine processes. Heston’s objective was to extend the Black-Scholes model =-=[15]-=-, for which the underlying price process is a geometric Brownian motion, to allow “stochastic volatility.” In [56], the underlying asset price is eZt ,where(Y,Z) is the affine process (m = n =1) defin... |

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Citation Context ...) Early prominent models of interest-rate behavior were based on such simple models of the short rate L(X) as the Vasicek (Gaussian Ornstein-Uhlenbeck) process [90], or the Cox-Ingersoll-Ross process =-=[30]-=-, which is the continuous branching diffusion of Feller [43]. Both of these short-rate processes are of course themselves affine (L(x) =x), as are many variants [20, 23, 30, 49, 58, 59, 72, 90, 74]. I... |

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Citation Context ...lay between the existence of moments of a bounded measure on RN and the regularity of its characteristic function. 1.1. Basic Notation. For the stochastic background and notation we refer to [57] and =-=[76]-=-. Let k ∈ N. Wewrite R k + = {x ∈ R k | xi ≥ 0, ∀i}, R k ++ = {x ∈ R k | xi > 0, ∀i}, C k + = {z ∈ C k | Re z ∈ R k +}, C k ++ = {z ∈ C k | Re z ∈ R k ++},sAFFINE PROCESSES 5 and analogously R k − , R... |

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Citation Context ...he corresponding ODEs. Regular affine processes include continuous-state branching processes with immigration (CBI) (for example, [62]) and processes of the Ornstein-Uhlenbeck (OU) type (for example, =-=[79]-=-). Roughly speaking, the regular affine processes with state space R m + are CBI, and those with state space Rn are of OU type. For any regular affine process X =(Y,Z) inR m + × R n , we show that the... |

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Citation Context ...the State Space. The preceding approach requires nonnegativity of L. But there is a large literature on affine term structures for which the short rate is not necessarily nonnegative. See for example =-=[90]-=- and [31]. We shall provide a different approach using the martingale argument from Theorem 2.12. Let L be as at the beginning of Section 11. For r ∈ R write R r t := r + � t 0 L(Xs) ds. It can be sho... |

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Citation Context ...tion 11, on a shortrate process L(X). We shall view Qtf(Xs) as the price at time s of a financial asset paying the amount f(Xs+t) attimes + t. This implies a particular “risk-neutral” interpretation (=-=[52, 32]-=-) of the semi-group (Pt) that we shall not detail here. We emphasize, however, that statistical analysis of time series of X, ormeasurement of the risk of changes in market values of financial assets,... |

427 | Modeling term structures of defaultable bonds
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Citation Context ...13.1), although with a different effective discount rate. The popularity of affine models of interest rates has thus led to the common application of affine processes to default modeling, as in [35], =-=[41]-=-, and [63]. A defaultable bond with maturity t is a financial asset paying 1 {τ>t} at t. Applying the doubly-stochastic property, Lando [63] showed that the defaultable bond has a price of Ex � e − � ... |

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Citation Context ...ξ)+···+ymµm(dξ), minus the killing rate C(x) =c + 〈γ,y〉. An informal definition of an affine process could consist of the requirement that A(x), B(x), C(x) andM(x, dξ) haveaffine dependence on x, see =-=[40]-=-. The particular kind of this affine dependence in the present setup is implied by the geometry of the state space D. First, we notice that A(x) ∈ Sem d , C(x) ≥ 0andM(x, D) ≥ 0, for all x ∈ D. Whence... |

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Citation Context ...e (11.10)). Indeed, given the desire to model interest rates with ever increasing realism, various higher-dimensional (d >1) variants have appeared [5, 6, 11, 14, 23, 30, 31, 54, 64, 69], and efforts =-=[13, 18, 31, 39, 46, 45]-=-, includingsAFFINE PROCESSES 51 this paper, have been directed to the classification and unification of affine termstructure models. Beyond the scope of our analysis here, there are in fact “infinited... |

376 |
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Citation Context ...faultable option may be likewise priced by replacing L(Xt) withL(Xt) + Λ(Xt), where {Λ(Xt−) : t ≥ 0} determines the default intensity, as for defaultable bond pricing. Numerous affine generalizations =-=[3, 4, 7, 8, 9, 24, 26, 40, 83, 84]-=- of the Heston model have been directed toward more realistic stochastic volatility and jump behavior. Pan [73] conducted a time-series analysis of the S-and-P 500 index data, both the underlying retu... |

337 | 2000), Specification Analysis of Affine Term Structure Models
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Citation Context ..., for any conservative regular affine process X =(Y,Z) inRm + × Rn , the sharp-brackets and jump characteristics of X depend only on the CBI component Y . This completes and extends the discussion in =-=[31]-=-, where they provide sufficient conditions for affine diffusion (and hence continuous) Markov processes to be well defined and classify them by the number m of Yis that can enter the conditional varia... |

279 |
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Citation Context ...faultable option may be likewise priced by replacing L(Xt) withL(Xt) + Λ(Xt), where {Λ(Xt−) : t ≥ 0} determines the default intensity, as for defaultable bond pricing. Numerous affine generalizations =-=[3, 4, 7, 8, 9, 24, 26, 40, 83, 84]-=- of the Heston model have been directed toward more realistic stochastic volatility and jump behavior. Pan [73] conducted a time-series analysis of the S-and-P 500 index data, both the underlying retu... |

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Citation Context ...faultable option may be likewise priced by replacing L(Xt) withL(Xt) + Λ(Xt), where {Λ(Xt−) : t ≥ 0} determines the default intensity, as for defaultable bond pricing. Numerous affine generalizations =-=[3, 4, 7, 8, 9, 24, 26, 40, 83, 84]-=- of the Heston model have been directed toward more realistic stochastic volatility and jump behavior. Pan [73] conducted a time-series analysis of the S-and-P 500 index data, both the underlying retu... |

236 |
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Citation Context ...hough with a different effective discount rate. The popularity of affine models of interest rates has thus led to the common application of affine processes to default modeling, as in [35], [41], and =-=[63]-=-. A defaultable bond with maturity t is a financial asset paying 1 {τ>t} at t. Applying the doubly-stochastic property, Lando [63] showed that the defaultable bond has a price of Ex � e − � t 0 L(Xs) ... |

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Citation Context ... process. We also show that a regular affine process X is (up to its lifetime) a semimartingale with respect to every Px, a crucial property in most financial applications because the standard model (=-=[53]-=-) of the financial gain generated by trading a security is a stochastic integral with respect to the underlying price process. We provide a one-to-one relationship between the coefficients of the char... |

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Citation Context ...defaultable bond pricing. Numerous affine generalizations [3, 4, 7, 8, 9, 24, 26, 40, 83, 84] of the Heston model have been directed toward more realistic stochastic volatility and jump behavior. Pan =-=[73]-=- conducted a time-series analysis of the S-and-P 500 index data, both the underlying returns as well as option prices, based on an affine jumpdiffusion model of returns. Special numerical methods for ... |

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Citation Context ...give the solution under non-negativity of L(X), or under conditions described at the end of Section 11. This is the Heston [56] approach to option pricing, building on earlier work of Stein and Stein =-=[88]-=- that did not exploit the properties of affine processes. Heston’s objective was to extend the Black-Scholes model [15], for which the underlying price process is a geometric Brownian motion, to allow... |

173 |
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Citation Context ...aultable option may be likewise priced by replacing L(Xt) with L(Xt) + Λ(Xt), where {Λ(Xt−) : t ≥ 0} determines the default intensity, as for defaultable bond pricing. Numerous affine generalizations =-=[3, 4, 7, 8, 9, 24, 27, 40, 79, 80]-=- of the Heston model have been directed toward more realistic stochastic volatility and jump behavior. Pan [72] conducted a time-series analysis of the S-and-P 500 index data, both the underlying retu... |

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Citation Context ...f work, summarized in Section 13, on pricing and measuring default risk exploits the properties of a doubly-stochastic counting process N driven by an affine process X. The stochastic intensity of N (=-=[16]-=-) is assumed to be of the form {Λ(Xt−) : t ≥ 0}, for some affine x ↦→ Λ(x). The time of default of a financial counterparty, such as a borrower or option writer, �s4 D. DUFFIE, D. FILIPOVIĆ, AND W. SC... |

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Citation Context ... equations for a broad range of affine processes (see (11.10)). Indeed, given the desire to model interest rates with ever increasing realism, various higher-dimensional (d >1) variants have appeared =-=[5, 6, 11, 14, 23, 30, 31, 54, 64, 69]-=-, and efforts [13, 18, 31, 39, 46, 45], includingsAFFINE PROCESSES 51 this paper, have been directed to the classification and unification of affine termstructure models. Beyond the scope of our analy... |

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Citation Context ...� t 0 (L(Xs)+Λ(Xs)) ds� . Because x ↦→ L(x) +Λ(x) is affine, the defaultable bond price is again of the tractable form of the default-free bond price (13.1), with new coefficients. Various approaches =-=[63, 60, 41, 71]-=- to modeling non-zero recovery at default have been adopted. For a model of the default times τ1,... ,τk of k>1 different financial contracts, an approach is to suppose that τi is the first jump time ... |

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Citation Context ... or the Cox-Ingersoll-Ross process [30], which is the continuous branching diffusion of Feller [43]. Both of these short-rate processes are of course themselves affine (L(x) =x), as are many variants =-=[20, 23, 30, 49, 58, 59, 72, 90, 74]-=-. In general, because 1 = e 〈0,x〉 , the bond price Qt1(x) =e A(t)+〈B(t),x〉 (13.1) is easily calculated from the generalized Riccati equations for a broad range of affine processes (see (11.10)). Indee... |

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Citation Context ...tion 11, on a shortrate process L(X). We shall view Qtf(Xs) as the price at time s of a financial asset paying the amount f(Xs+t) attimes + t. This implies a particular “risk-neutral” interpretation (=-=[52, 32]-=-) of the semi-group (Pt) that we shall not detail here. We emphasize, however, that statistical analysis of time series of X, ormeasurement of the risk of changes in market values of financial assets,... |

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Citation Context ...� t 0 (L(Xs)+Λ(Xs)) ds� . Because x ↦→ L(x) +Λ(x) is affine, the defaultable bond price is again of the tractable form of the default-free bond price (13.1), with new coefficients. Various approaches =-=[63, 60, 41, 71]-=- to modeling non-zero recovery at default have been adopted. For a model of the default times τ1,... ,τk of k>1 different financial contracts, an approach is to suppose that τi is the first jump time ... |

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Citation Context ...d on such simple models of the short rate L(X) as the Vasicek (Gaussian Ornstein-Uhlenbeck) process [90], or the Cox-Ingersoll-Ross process [30], which is the continuous branching diffusion of Feller =-=[43]-=-. Both of these short-rate processes are of course themselves affine (L(x) =x), as are many variants [20, 23, 30, 49, 58, 59, 72, 90, 74]. In general, because 1 = e 〈0,x〉 , the bond price Qt1(x) =e A(... |

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Citation Context ...en based on approximation of the likelihood function [68, 40], on generalized method of moments [48] or on spectral properties, making use of the easily calculated complex moments of affine processes =-=[61, 21, 86]-=-. 13.2. Default Risk. In order to model the timing of default of financial contracts, we suppose that N is a non-explosive counting process [16] (defined on an enlarged probability space) that is doub... |

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Citation Context ...ts, such as jumps and stochastic volatility in various forms. In addition to applications summarized below regarding the valuation of financial assets in settings of affine processes, recent progress =-=[17, 22, 66, 67, 80, 81, 82, 93]-=- in the modeling of optimal dynamic portfolio and consumption choice has exploited the special structure of controlled affine state-process models. We fix a conservative regular affine process X with ... |

67 | 2003, “Dynamic Asset Allocation with Event Risk
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Citation Context ...ts, such as jumps and stochastic volatility in various forms. In addition to applications summarized below regarding the valuation of financial assets in settings of affine processes, recent progress =-=[17, 22, 66, 67, 80, 81, 82, 93]-=- in the modeling of optimal dynamic portfolio and consumption choice has exploited the special structure of controlled affine state-process models. We fix a conservative regular affine process X with ... |

60 | Optimal Consumption and Portfolio Selection with Stochastic Differential Utility
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Citation Context ...ts, such as jumps and stochastic volatility in various forms. In addition to applications summarized below regarding the valuation of financial assets in settings of affine processes, recent progress =-=[17, 22, 66, 67, 80, 81, 82, 93]-=- in the modeling of optimal dynamic portfolio and consumption choice has exploited the special structure of controlled affine state-process models. We fix a conservative regular affine process X with ... |

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Citation Context ...7]. Empirical analyses of interest-rate behavior based on the properties of affine models include [19, 25, 31, 34, 36, 50, 55, 65, 74, 75, 91], with a related analysis of foreign-currency forwards in =-=[2]-=-. Statistical methods developed specifically for the analysis of time-series data from affine models have been based on approximation of the likelihood function [68, 40], on generalized method of mome... |

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Citation Context ...equations for a broad range of affine processes (see (11.10)). Indeed, given the desire to model interest rates with ever increasing realism, various higher-dimensional (d > 1) variants have appeared =-=[5, 6, 11, 14, 23, 30, 31, 63, 68]-=-, and efforts [13, 18, 31, 39, 46, 45], includingAFFINE PROCESSES AND APPLICATIONS IN FINANCE 51 this paper, have been directed to the classification and unification of affine termstructure models. B... |

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Citation Context ... equations for a broad range of affine processes (see (11.10)). Indeed, given the desire to model interest rates with ever increasing realism, various higher-dimensional (d >1) variants have appeared =-=[5, 6, 11, 14, 23, 30, 31, 54, 64, 69]-=-, and efforts [13, 18, 31, 39, 46, 45], includingsAFFINE PROCESSES 51 this paper, have been directed to the classification and unification of affine termstructure models. Beyond the scope of our analy... |

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Citation Context ... of our analysis here, there are in fact “infinitedimensional affine term-structure models” [51, 28, 27]. Empirical analyses of interest-rate behavior based on the properties of affine models include =-=[19, 25, 31, 34, 36, 50, 55, 65, 74, 75, 91]-=-, with a related analysis of foreign-currency forwards in [2]. Statistical methods developed specifically for the analysis of time-series data from affine models have been based on approximation of th... |

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Citation Context ...ciated with the generator are in a one-to-one relation with those of the corresponding ODEs. Regular affine processes include continuous-state branching processes with immigration (CBI) (for example, =-=[62]-=-) and processes of the Ornstein-Uhlenbeck (OU) type (for example, [79]). Roughly speaking, the regular affine processes with state space R m + are CBI, and those with state space Rn are of OU type. Fo... |

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Citation Context ...r, have been directed to the classification and unification of affine termstructure models. Beyond the scope of our analysis here, there are in fact “infinitedimensional affine term-structure models” =-=[51, 26, 28]-=-. Empirical analyses of interest-rate behavior based on the properties of affine models include [19, 25, 31, 34, 36, 50, 54, 64, 73, 87], with a related analysis of foreign-currency forwards in [2]. S... |

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Citation Context ... equations for a broad range of affine processes (see (11.10)). Indeed, given the desire to model interest rates with ever increasing realism, various higher-dimensional (d >1) variants have appeared =-=[5, 6, 11, 14, 23, 30, 31, 54, 64, 69]-=-, and efforts [13, 18, 31, 39, 46, 45], includingsAFFINE PROCESSES 51 this paper, have been directed to the classification and unification of affine termstructure models. Beyond the scope of our analy... |

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Citation Context ...cess. We provide a one-to-one relationship between the coefficients of the characteristic function of a conservative regular affine process X and (up to a version) its semimartingale characteristics (=-=[57]-=-) (B,C,ν) (after fixing a truncation of jumps), of which B is the predictable component of the canonical decomposition of X, C is the “sharpbrackets” process, and ν is the compensator of the random ju... |

36 |
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Citation Context ...defaultable bond pricing. Numerous affine generalizations [3, 4, 7, 8, 9, 24, 27, 40, 79, 80] of the Heston model have been directed toward more realistic stochastic volatility and jump behavior. Pan =-=[72]-=- conducted a time-series analysis of the S-and-P 500 index data, both the underlying returns as well as option prices, based on an affine jumpdiffusion model of returns. Special numerical methods for ... |

34 |
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Citation Context ...r, have been directed to the classification and unification of affine termstructure models. Beyond the scope of our analysis here, there are in fact “infinitedimensional affine term-structure models” =-=[51, 28, 27]-=-. Empirical analyses of interest-rate behavior based on the properties of affine models include [19, 25, 31, 34, 36, 50, 55, 65, 74, 75, 91], with a related analysis of foreign-currency forwards in [2... |

31 |
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Citation Context ...e (11.10)). Indeed, given the desire to model interest rates with ever increasing realism, various higher-dimensional (d >1) variants have appeared [5, 6, 11, 14, 23, 30, 31, 54, 64, 69], and efforts =-=[13, 18, 31, 39, 46, 45]-=-, includingsAFFINE PROCESSES 51 this paper, have been directed to the classification and unification of affine termstructure models. Beyond the scope of our analysis here, there are in fact “infinited... |

30 |
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Citation Context ...v process with state space Rm + , independently of z ∈ Rn . Theorem 2.7 generalizes and unifies two classical types of stochastic processes. For the notion of a CBI process we refer to [94], [62] and =-=[85]-=-. For the notion of an OU type process see [79, Definition 17.2]. Corollary 2.10. Let X =(Y,Z) be regular affine. Then (Y,(P (y,z))y∈R m + ) is a CBI process, for every z ∈ R n .Ifm =0then X is an OU ... |

28 |
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Citation Context |

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Consistency problems for Heath–Jarrow–Morton interest rate models
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Citation Context ...e (11.10)). Indeed, given the desire to model interest rates with ever increasing realism, various higher-dimensional (d >1) variants have appeared [5, 6, 11, 14, 23, 30, 31, 54, 64, 69], and efforts =-=[13, 18, 31, 39, 46, 45]-=-, includingsAFFINE PROCESSES 51 this paper, have been directed to the classification and unification of affine termstructure models. Beyond the scope of our analysis here, there are in fact “infinited... |

27 | Affine Term Structure Models
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Citation Context ... of our analysis here, there are in fact “infinitedimensional affine term-structure models” [51, 28, 27]. Empirical analyses of interest-rate behavior based on the properties of affine models include =-=[19, 25, 31, 34, 36, 50, 55, 65, 74, 75, 91]-=-, with a related analysis of foreign-currency forwards in [2]. Statistical methods developed specifically for the analysis of time-series data from affine models have been based on approximation of th... |

21 |
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Citation Context ... or the Cox-Ingersoll-Ross process [30], which is the continuous branching diffusion of Feller [43]. Both of these short-rate processes are of course themselves affine (L(x) =x), as are many variants =-=[20, 23, 30, 49, 58, 59, 72, 90, 74]-=-. In general, because 1 = e 〈0,x〉 , the bond price Qt1(x) =e A(t)+〈B(t),x〉 (13.1) is easily calculated from the generalized Riccati equations for a broad range of affine processes (see (11.10)). Indee... |

17 |
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Citation Context |