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Introduction
1.1 THE NEED FOR BETTER FINANCIAL MODELING OF ASSET PRICES
1.2 THE FAMILY OF STABLE DISTRIBUTION AND ITS PROPERTIES
1.2.1 Parameterization of the Stable Distribution
1.2.2 Desirable Properties of the Stable Distributions
1.3 OPTION PRICING WITH VOLATILITY CLUSTERING
1.3.1 Non-Gaussian GARCH Models
1.6 ORGANIZATION OF THE BOOK
REFERENCES
Probability Distributions
2.2 DISCRETE PROBABILITY DISTRIBUTIONS
2.2.1 Bernoulli Distribution
2.2.2 Binomial Distribution
2.2.3 Poisson Distribution
2.3 CONTINUOUS PROBABILITY DISTRIBUTIONS
2.3.2 Normal Distribution
2.3.3 Exponential Distribution
2.3.4 Gamma Distribution
2.3.5 Variance Gamma Distribution
2.3.6 Inverse Gaussian Distribution
2.4 STATISTIC MOMENTS AND QUANTILES
2.4.1 Location
2.4.2 Dispersion
2.4.3 Asymmetry
2.4.4 Concentration in Tails
2.4.5 Statistical Moments
2.4.6 Quantiles
2.4.7 Sample Moments
2.5 CHARACTERISTIC FUNCTION
2.6 JOINT PROBABILITY DISTRIBUTIONS
2.6.1 Conditional Probability
2.6.2 Joint Probability Distribution Defined
2.6.3 Marginal Distribution
2.6.4 Dependence of Random Variables
2.6.5 Covariance and Correlation
2.6.6 Multivariate Normal Distribution
2.6.7 Elliptical Distributions
2.6.8 Copula Functions
2.7 SUMMARY
Stable and Tempered Stable Distributions
3.1 α-STABLE DISTRIBUTION
3.1.1 Definition of an α-Stable Random Variable
3.1.2 Useful Properties of an α-Stable Random Variable
3.1.3 Smoothly Truncated Stable Distribution
3.2 TEMPERED STABLE DISTRIBUTIONS
3.2.1 Classical Tempered Stable Distribution
3.2.3 Modified Tempered Stable Distribution
3.2.4 Normal Tempered Stable Distribution
3.2.5 Kim-Rachev Tempered Stable Distribution
3.2.6 Rapidly Decreasing Tempered Stable Distribution
3.3 INFINITELY DIVISIBLE DISTRIBUTIONS
3.3.1 Exponential Moments
3.4 SUMMARY
3.5 APPENDIX
3.5.1 The Hypergeometric Function
3.5.2 The Confluent Hypergeometric Function
Stochastic Processes in Continuous Time
4.1 SOME PRELIMINARIES
4.2 POISSON PROCESS
4.2.1 Compounded Poisson Process
4.3 PURE JUMP PROCESS
4.3.1 Gamma Process
4.3.2 Inverse Gaussian Process
4.3.3 Variance Gamma Process
4.3.4 α-Stable Process
4.3.5 Tempered Stable Process
4.4 BROWNIAN MOTION
4.4.1 Arithmetic Brownian Motion
4.4.2 Geometric Brownian Motion
4.5 TIME-CHANGED BROWNIAN MOTION
4.5.1 Variance Gamma Process
4.5.2 Normal Inverse Gaussian Process
4.5.3 Normal Tempered Stable Process
4.6 L´EVY PROCESS
4.7 SUMMARY
Conditional Expectation and Change of Measure
5.1 EVENTS, σ-FIELDS, AND FILTRATION
5.2 CONDITIONAL EXPECTATION
5.3 CHANGE OF MEASURES
5.3.1 Equivalent Probability Measure
5.3.3 Change of Measure in Tempered Stable Processes
5.4 SUMMARY
Exponential L´evy Models
6.1 EXPONENTIAL L ´EVY MODELS
6.2 FITTING α-STABLE AND TEMPERED STABLE DISTRIBUTIONS
6.2.1 Fitting the Characteristic Function
6.2.3 Assessing the Goodness of Fit
6.4 SUMMARY
6.5.1 Numerical Method for the Fourier Transform
Option Pricing in Exponential L´evy Models
7.1 OPTION CONTRACT
7.2 BOUNDARY CONDITIONS FOR THE PRICE OF AN OPTION
7.3 NO-ARBITRAGE PRICING AND EQUIVALENT MARTINGALE MEASURE
7.4 OPTION PRICING UNDER THE BLACK-SCHOLES MODEL
7.5.1 Illustration: Implied Volatility
7.5.2 Illustration: Calibrating Risk-Neutral Parameters
7.6 SUBORDINATED STOCK PRICE MODEL
7.6.1 Stochastic Volatility L ´evy Process Model
7.7 SUMMARY
Simulation
8.1 RANDOM NUMBER GENERATORS
8.1.1 Uniform Distributions
8.1.2 Discrete Distributions
8.1.3 Continuous Nonuniform Distributions
8.1.4 Simulation of Particular Distributions
8.2 SIMULATION TECHNIQUES FOR L ´EVY PROCESSES
8.2.1 Taking Care of Small Jumps
8.2.2 Series Representation: A General Framework
8.2.3 Rosi ´nsky Rejection Method
Rosi´nsky rejection method
8.2.4 α-Stable Processes
8.3 TEMPERED STABLE PROCESSES
8.3.1 Kim-Rachev Tempered Stable Case
8.3.2 Classical Tempered Stable Case
8.4 TEMPERED INFINITELY DIVISIBLE PROCESSES
8.4.1 Rapidly Decreasing Tempered Stable Case
8.4.2 Modified Tempered Stable Case
8.5 TIME-CHANGED BROWNIAN MOTION
8.5.1 Classical Tempered Stable Processes
8.5.3 Normal Tempered Stable Processes
8.5.4 Normal Inverse Gaussian Processes
8.6 MONTE CARLO METHODS
8.6.1 Variance Reduction Techniques
8.6.2 A Nonparametric Monte Carlo Method
8.6.3 A Monte Carlo Example
APPENDIX
Multi-Tail t-Distribution
9.1 INTRODUCTION
9.2 PRINCIPAL COMPONENT ANALYSIS
9.2.1 Principal Component Tail Functions
9.2.2 Density of Multi-Tail t Random Variable
9.3 ESTIMATING PARAMETERS
9.3.1 Estimation of the Dispersion Matrix
9.3.2 Estimation of the Parameter Set
9.4 EMPIRICAL RESULTS
9.4.1 Comparison to Other Models
9.4.2 Two-Dimensional Analysis
9.4.3 Multi-Tail t Model Check for the DAX
9.5 SUMMARY
Non-Gaussian Portfolio Allocation
10.1 INTRODUCTION
10.2 MULTIFACTOR LINEAR MODEL
10.5 OPTIMAL PORTFOLIOS
10.6 THE ALGORITHM
10.7 AN EMPIRICAL TEST
10.8 SUMMARY
Normal GARCH Models
11.1 INTRODUCTION
11.2 GARCH DYNAMICS WITH NORMAL INNOVATION
11.3 MARKET ESTIMATION
11.4 RISK-NEUTRAL ESTIMATION
11.4.1 Out-of-Sample Performance
11.5 SUMMARY
Smoothly Truncated Stable GARCH Models
12.1 INTRODUCTION
12.2 A GENERALIZED NGARCH OPTION PRICING MODEL
12.3 EMPIRICAL ANALYSIS
12.3.1 Results Under the Objective Probability Measure
12.3.2 Explaining S&P 500 Option Prices
Inﬁnitely Divisible GARCH Models
13.1 STOCK PRICE DYNAMIC
13.2 RISK-NEUTRAL DYNAMIC
13.3 NON-NORMAL INFINITELY DIVISIBLE GARCH
13.3.1 Classical Tempered Stable Model
13.3.2 Generalized Tempered Stable Model
13.3.3 Kim-Rachev Model
13.3.4 Rapidly Decreasing Tempered Stable Model
13.3.5 Inverse Gaussian Model
13.4 SIMULATE INFINITELY DIVISIBLE GARCH
Option Pricing with Monte Carlo Methods
American Option Pricing with Monte Carlo Methods
Index
P. 1
Financial Models with Levy Processes and Volatility Clustering

# Financial Models with Levy Processes and Volatility Clustering

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An in-depth guide to understanding probability distributions and financial modeling for the purposes of investment managementIn Financial Models with Lévy Processes and Volatility Clustering, the expert author team provides a framework to model the behavior of stock returns in both a univariate and a multivariate setting, providing you with practical applications to option pricing and portfolio management. They also explain the reasons for working with non-normal distribution in financial modeling and the best methodologies for employing it.The book's framework includes the basics of probability distributions and explains the alpha-stable distribution and the tempered stable distribution. The authors also explore discrete time option pricing models, beginning with the classical normal model with volatility clustering to more recent models that consider both volatility clustering and heavy tails.Reviews the basics of probability distributionsAnalyzes a continuous time option pricing model (the so-called exponential Lévy model)Defines a discrete time model with volatility clustering and how to price options using Monte Carlo methodsStudies two multivariate settings that are suitable to explain joint extreme eventsFinancial Models with Lévy Processes and Volatility Clustering is a thorough guide to classical probability distribution methods and brand new methodologies for financial modeling.
An in-depth guide to understanding probability distributions and financial modeling for the purposes of investment managementIn Financial Models with Lévy Processes and Volatility Clustering, the expert author team provides a framework to model the behavior of stock returns in both a univariate and a multivariate setting, providing you with practical applications to option pricing and portfolio management. They also explain the reasons for working with non-normal distribution in financial modeling and the best methodologies for employing it.The book's framework includes the basics of probability distributions and explains the alpha-stable distribution and the tempered stable distribution. The authors also explore discrete time option pricing models, beginning with the classical normal model with volatility clustering to more recent models that consider both volatility clustering and heavy tails.Reviews the basics of probability distributionsAnalyzes a continuous time option pricing model (the so-called exponential Lévy model)Defines a discrete time model with volatility clustering and how to price options using Monte Carlo methodsStudies two multivariate settings that are suitable to explain joint extreme eventsFinancial Models with Lévy Processes and Volatility Clustering is a thorough guide to classical probability distribution methods and brand new methodologies for financial modeling.

Publish date: Feb 2, 2011
Added to Scribd: Mar 07, 2011

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