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"Derivative securities Valuation Mathematical models."
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Hedging derivatives
Valuation and hedging of financial derivatives are intrinsically linked concepts. Choosing appropriate hedging techniques depends on both the type of derivative and assumptions placed on the underlying stochastic process. This volume provides a systematic treatment of hedging in incomplete markets. Mean-variance hedging under the risk-neutral measure is applied in the framework of exponential Lévy processes and for derivatives written on defaultable assets. It is discussed how to complete markets based upon stochastic volatility models via trading in both stocks and vanilla options. Exponential utility indifference pricing is explored via a duality with entropy minimization. Backward stochastic differential equations offer an alternative approach and are moreover applied to study markets with trading constraints including basis risk. A range of optimal martingale measures are discussed including the entropy, Esscher and minimal martingale measures. Quasi-symmetry properties of stochastic processes are deployed in the semi-static hedging of barrier options.
eBook
Counterparty Credit Risk, Collateral and Funding
\"The book's content is focused on rigorous and advanced quantitative methods for the pricing and hedging of counterparty credit and funding risk. The new general theory that is required for this methodology is developed from scratch, leading to a consistent and comprehensive framework for counterparty credit and funding risk, inclusive of collateral, netting rules, possible debit valuation adjustments, re-hypothecation and closeout rules. The book however also looks at quite practical problems, linking particular models to particular 'concrete' financial situations across asset classes, including interest rates, FX, commodities, equity, credit itself, and the emerging asset class of longevity. The authors also aim to help quantitative analysts, traders, and anyone else needing to frame and price counterparty credit and funding risk, to develop a 'feel' for applying sophisticated mathematics and stochastic calculus to solve practical problems. The main models are illustrated from theoretical formulation to final implementation with calibration to market data, always keeping in mind the concrete questions being dealt with. The authors stress that each model is suited to different situations and products, pointing out that there does not exist a single model which is uniformly better than all the others, although the problems originated by counterparty credit and funding risk point in the direction of global valuation. Finally, proposals for restructuring counterparty credit risk, ranging from contingent credit default swaps to margin lending, are considered\"--provided by publisher.
eBook
Options as Silver Bullets: Valuation of Term Loans, Inventory Management, Emissions Trading and Insurance Risk Mitigation using Option Theory
Models to price long term loans in the securities lending business are developed. These longer horizon deals can be viewed as contracts with optionality embedded in them. This insight leads to the usage of established methods from derivatives theory to price such contracts. Numerical simulations are used to demonstrate the practical applicability of these models. The techniques advanced here can lead to greater synergies between the management of derivative and delta-one trading desks, perhaps even being able to combine certain aspects of the day to day operations of these seemingly disparate entities. These models are part of one of the least explored, yet profit laden, areas of modern management. A heuristic is developed to mitigate any loss of information, which might set in when parameters are estimated first and then the valuations are performed, by directly calculating valuations using the historical time series. This approach to valuations can lead to reduced models errors, robust estimation systems, greater financial stability and economic strength. An illustration is provided regarding how the methodologies developed here could be useful for inventory management, emissions trading and insurance risk mitigation. All these techniques could have applications for dealing with other financial instruments, non-financial commodities and many forms of uncertainty.
Journal Article
A novel technique using integral transforms and residual functions for nonlinear partial fractional differential equations involving Caputo derivatives
Fractional nonlinear partial differential equations are used in many scientific fields to model various processes, although most of these equations lack closed-form solutions. For this reason, methods for approximating solutions that occasionally yield closed-form solutions are crucial for solving these equations. This study introduces a novel technique that combines the residual function and a modified fractional power series with the Elzaki transform to solve various nonlinear problems within the Caputo derivative framework. The accuracy and effectiveness of our approach are validated through analyses of absolute, relative, and residual errors. We utilize the limit principle at zero to identify the coefficients of the series solution terms, while other methods, including variational iteration, homotopy perturbation, and Adomian, depend on integration. In contrast, the residual power series method uses differentiation, and both approaches encounter difficulties in fractional contexts. Furthermore, the effectiveness of our approach in addressing nonlinear problems without relying on Adomian and He polynomials enhances its superiority over various approximate series solution techniques.
Journal Article
Applying fractional calculus to malware spread: A fractal-based approach to threat analysis
Malware is a common word in modern era. Everyone using computer is aware of it. Some users have to face the problem known as Cyber crimes. Nobody can survive without use of modern technologies based on computer networking. To avoid threat of malware, different companies provide antivirus strategies on a high cost. To prevent the data and keep privacy, companies using computers have to buy these antivirus programs (software). Software varies due to types of malware and is developed on structure of malware with a deep insight on behavior of nodes. We selected a mathematical malware propagation model having variable infection rate. We were interested in examining the impact of memory effects in this dynamical system in the sense of fractal fractional (FF) derivatives. In this paper, theoretical analysis is performed by concepts of fixed point theory. Existence, uniqueness and stability conditions are investigated for FF model. Numerical algorithm based on Lagrange two points interpolation polynomial is formed and simulation is done using Matlab R2016a on the deterministic model. We see the impact of different FF orders using power law kernel. Sensitivity analysis of different parameters such as initial infection rate, variable adjustment to sensitivity of infected nodes, immune rate of antivirus strategies and loss rate of immunity of removed nodes is investigated under FF model and is compared with classical. On investigation, we find that FF model describes the effects of memory on nodes in detail. Antivirus software can be developed considering the effect of FF orders and parameters to reduce persistence and eradication of infection. Small changes cause significant perturbation in infected nodes and malware can be driven into passive mode by understanding its propagation by FF derivatives and may take necessary actions to prevent the disaster caused by cyber crimes.
Journal Article
Additive logistic processes in option pricing
In option pricing, it is customary to first specify a stochastic underlying model and then extract valuation equations from it. However, it is possible to reverse this paradigm: starting from an arbitrage-free option valuation formula, one could derive a family of risk-neutral probabilities and a corresponding risk-neutral underlying asset process. In this paper, we start from two simple arbitrage-free valuation equations, inspired by the log-sum-exponential function and an ℓp vector norm. Such expressions lead respectively to logistic and Dagum (or “log-skew-logistic”) risk-neutral distributions for the underlying security price. We proceed to exhibit supporting martingale processes of additive type for underlying securities having as time marginals two such distributions. By construction, these processes produce closed-form valuation equations which are even simpler than those of the Bachelier and Samuelson–Black–Scholes models. Additive logistic processes provide parsimonious and simple option pricing models capturing various important stylised facts at the minimum price of a single market observable input.
Journal Article
Option pricing in the Heston model with physics inspired neural networks
In absence of a closed form expression such as in the Heston model, the option pricing is computationally intensive when calibrating a model to market quotes. this article proposes an alternative to standard pricing methods based on physics-inspired neural networks (PINNs). A PINN integrates principles from physics into its learning process to enhance its efficiency in solving complex problems. In this article, the driving principle is the Feynman-Kac (FK) equation, which is a partial differential equation (PDE) governing the derivative price in the Heston model. We focus on the valuation of European options and show that PINNs constitute an efficient alternative for pricing options with various specifications and parameters without the need for retraining.
Journal Article
Estimation and Evaluation of Conditional Asset Pricing Models
We find that several recently proposed consumption-based models of stock returns, when evaluated using an optimal set of managed portfolios and the associated model-implied conditional moment restrictions, fail to capture key features of risk premiums in equity markets. To arrive at these conclusions, we construct an optimal Generalized Method of Moments (GMM) estimator for models in which the stochastic discount factor (SDF) is a conditionally affine function of a set of priced risk factors, and we show that there is an optimal choice of managed portfolios to use in testing a null model against a proposed alternative generalized SDF.
Journal Article
A Top-Down Approach to Multiname Credit
A multiname credit derivative is a security that is tied to an underlying portfolio of corporate bonds and has payoffs that depend on the loss due to default in the portfolio. The value of a multiname derivative depends on the distribution of portfolio loss at multiple horizons. Intensity-based models of the loss point process that are specified without reference to the portfolio constituents determine this distribution in terms of few economically meaningful parameters and lead to computationally tractable derivatives valuation problems. However, these models are silent about the portfolio constituent risks. They cannot be used to address applications that are based on the relationship between portfolio and component risks, for example, constituent risk hedging. This paper develops a method that extends these models to the constituents. We use random thinning to decompose the portfolio intensity into a sum of constituent intensities. We show that a thinning process, which allocates the portfolio intensity to constituents, uniquely exists, and is a probabilistic model for the next-to-default. We derive a formula for the constituent default probability in terms of the thinning process and the portfolio intensity, and develop a semi-analytical transform approach to evaluate it. The formula leads to a calibration scheme for the thinning processes and an estimation scheme for constituent hedge sensitivities. An empirical analysis for September 2008 shows that the constituent hedges generated by our method outperform the hedges prescribed by the Gaussian copula model, which is widely used in practice.
Journal Article