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November 1-2, 2010

New York, NY

Black Holes or Black Scholes: Modeling

Long-dated Options

Paul Staneski

1

Black Black--Scholes or Black Holes? Scholes or Black Holes?

Issues in modeling long Issues in modeling long- -dated options dated options

1 N b 2010 1 N b 2010

Black Black Scholes or Black Holes? Scholes or Black Holes?

1 November 2010 1 November 2010

1330 1330 –– 1415 hrs 1415 hrs

Paul Staneski, Ph.D.

Credit Suisse

Head of Derivatives Solutions & Training

Society of Actuaries Equity-Based Guarantees Conference New York

2

It’s a Model!

“All models are wrong, some are useful.”

George Box/Gwilym Jenkins George Box/Gwilym Jenkins

Slide 2

3

Some Issues

The role of Gamma

Rho vs. Vega g

– Relative impacts over time

Variance Swaps

– Short-term vs. long-term replication

Realized vs. Implied Vol

– How do you price?

– How do you hedge?

Slide 3

4

Black-Scholes

The “Black-Scholes” model rivals CAPM (the Capital Asset Pricing Model) as

the most important result in the history of finance.

– Fischer Black and Myron Scholes, “The Pricing of Options and Corporate Liabilities”, y g p p

Journal of Political Economy, 81 (May-June 1973), pp. 637-659.

– Scholes and Robert Merton won the 1997 Nobel Prize in Economics for this work

(Black died in 1995 and the prizes are not awarded posthumously).

Historical note: Ed Thorp actually first derived this result in 1967!

– Read “Fortune’s Formula” by William Poundstone, Hill & Wang, 2005.

Slide 4

5

Black-Scholes in a Nutshell

Option

∆Stock

Slide 5

(“balance” with financing)

6

The Greeks are Key!

Slide 6

7

Delta Hedging & Gamma

Value

Long Call

Hedge (Short Stock)

Gain on Long Call

Gain on Hedge

Loss on Hedge

Loss on Call

Stock Price

Because of gamma the hedged position has a net gain regardless of the move in spot

Slide 7

Because of gamma, the hedged position has a net gain regardless of the move in spot.

8

Capturing Gamma

Hedging & re-hedging a long call …

P/L P/L

S

1

S

2

Stock Price

Initial Premium

S

1

S

2

Gamma “captured”

Slide 8

9

Capturing (More) Gamma

Hedging & re-hedging a long call …

P/L P/L

S

3

S

1

S

2

Stock Price

Initial Premium

S

3

S

1

S

2

Gamma “captured”

Gamma “captured”

Gamma captured

Slide 9

10

Model Assumptions

Under all the model’s assumptions (there are many!) the application of the

model to a 10-day option is not at all different than its application to a 10-year

option.

However, in the “real world” this time invariance is not the case!

The “troublesome” assumptions The troublesome assumptions …

Constant interest rates (and dividends)

Constant volatility

Slide 10

11

Question

Suppose you buy a 90-day Call option on a stock at an implied volatility of

35% and dynamically hedge it (perfectly, as per the Black-Scholes

assumptions) to expiration. If realized volatility over the 90 days is 40%, will

k ? you make money?

– Answer: ____________

Slide 11

12

Answer

Not necessarily!

You expect to make money, but given the particular price path of the stock p y, g p p p

you might not.

Slide 12

13

Where’s your gamma?

These two price paths have exactly the same vol …

A B

… but gamma is not constant over time.

Which one would rather be hedging over? Answer:

Slide 13

Which one would rather be hedging over? Answer: _________

14

Gamma and Time

0

.

0

5

X = 100, vol = 16%, r = 4%

m

a

0

.

0

3

0

.

0

4

t = 0.25

G

a

m

m

0

1

0

.

0

2

t = 1

60 80 100 120 140

0

.

0

0

.

0

t 1

Slide 14

Spot

60 80 100 120 140

15

Non-Constant Gamma

The “path-dependency” problem induced by non-constant gamma over time

is not a serious issue for short-dated options.

Large volumes generally ensure that the “expected” nature of hedging profits

prevails.

However because many fewer long dated options are traded this “averaging” However, because many fewer long-dated options are traded this averaging

out may not occur.

Slide 15

16

More Greeks: Vega and Rho

The change in an option’s value given a change in volatility is known as vega

…

σ

C

ity in volatil chg

ue option val in chg.

Vega

c

c

= =

– Also known as tau or kappa.

σ ity in volatil chg. c

– Unit of change in vol is an absolute 1% (e.g., 25% to 26%).

The change in an option’s value given a change in rates is known as rho …

– Unit of change in rates is usually taken to be an absolute 1% (100 bps).

r

C

rates in chg.

ue option val in chg.

Rho

c

c

= = = p

Slide 16

17

Vega and Rho

Slide 17

Question: Why does the put value rise then begin to decline?

18

Vega vs. Rho over Time

Rho increases absolutely with time but vega actually starts to decline …

Slide 18

19

Vega/Put vs. Rho/Put

Rho will eventually exceed the value of the put!

Slide 19

y p

20

Hedging Rho

For short-dated options, and especially in this low rate and low rate-vol

environment, rho is not a big concern for equity-option traders.

Rho risk that is generated by trading equity options can be hedged with FRAs

and Eurodollar Futures.

For long dated options as we have seen rho risk becomes significant and this For long-dated options, as we have seen, rho risk becomes significant and this

long-dated rate risk is not as easily hedged.

– A 100 bp change in rates is very unlikely in the next 3 months, but is virtually certain

over the next 10 years.

Slide 20

21

Stochastic Interest Rates

Interest-rate sensitive derivatives can be priced with a model that allows for the

evolution of rates (“stochastic” interest rates) over time.

Modelling rates is fundamentally more complex than modelling equities.

– What rate to model?

Short rate (LIBOR)?

Ri k f ( T )? Risk-free (e.g., Treasury)?

Forward rate(s)?

– What distributional assumption?

Normal? Normal?

Lognormal?

This has lead to a plethora of models.

Slide 21

22

More Questions

Do rates mean revert?

Is vol dependent on the level of rates? p

– Are the vols of spot rates and forward rates different?

How important is “fitting the market”?

– What is to be “fit”?

Zero-coupon bond prices?

Forward rates?

Option prices (caps floors swaptions)? Option prices (caps, floors, swaptions)?

Slide 22

23

Basic Model Structure

Is a model a model of what is (that is, calibrated to market prices) or what

should be (equilibrium models)?

– Equilibrium models: term structure of rates is an output. q p

– Market (“no-arbitrage”) models: term structure is an input.

Models that “fit the market” all suffer from the same problems as Black-

S h l h d i l d d i i diffi l Scholes: hedging long-dated instruments is difficult.

Equilibrium models often yield “unsatisfactory” prices.

Slide 23

24

One-Factor Interest Rate Models

All of these models do a reasonable job of pricing, but alone do not provide

adequate hedging strategies adequate hedging strategies.

Multi-factor models also exist.

Slide 24

25

Variance Swaps

Variance Swap: a contract that pays the difference between the realized

variance and a fixed level of variance (the “strike”).

– Payoff = M*(Realized Variance Ӎ Strike Variance) Payoff M (Realized Variance Strike Variance)

– The “multiplier” M = notional size of the contract (“Variance Units”)

– Really just a Forward.

Note 1: The strike is quoted in vol terms (20%, for example) even though the

contract is valued as the difference between variances.

Note 2: Despite how the strike is quoted, M is chosen to achieve a specific

“vega notional” or vega amount (change in value of swap given a 1% change in

vol).

Slide 25

26

Replicating/Hedging a Variance Swap

The payoff of a variance swap is replicated, and hence hedged, by a weighted

portfolio of out-of-the-money (with respect to the Forward) puts and calls.

Imp. Vol

The weights are in inverse

proportion to the square of strike.

Buy all these options …

Strike

Out-of-the-money Puts F Out-of-the-money Calls

Slide 26

27

Short vs. Long-Dated Variance Swaps

Given the replicating portfolio of a variance swap, it is clear that a reasonably

wide, liquid strip of options is necessary.

For short-dated swaps ( < 1 year), such options trade with sufficient liquidity on

major indices.

For long dated swaps it is hard to hedge properly and market makers thus try For long-dated swaps, it is hard to hedge properly and market makers thus try

to match buyers with sellers.

Slide 27

28

Valuing an Option: Inputs

In order to value an option, we need to know …

– Spot price (S)

– Strike Price (X) Strike Price (X)

– Interest rates (r) (and dividend yield, if applicable)

– Time to expiration (t)

– (Expected) Volatility ( )

σ

r

X

S

Valuation Model

V l

σ

t

r

Valuation Model

(Black-Scholes?)

Option Value

Slide 28

29

Option Pricing Models ?

Models yield values … markets give us prices!

Slide 29

30

Implied Volatility

The “character” of the 5 inputs is different: S, X, r, and t are all observable

(and essentially unequivocal), volatility is not.

What we can observe in the market, however, is the price of an option.

We can “reverse-engineer” the model to solve for the volatility that would

produce this price (along with the other known inputs) produce this price (along with the other known inputs) …

Valuation Model

(Black-Scholes)

Implied Vol Option Price

Slide 30

31

Realized Volatility

Realized volatility is a statistical calculation; it is the observed (annualized)

standard deviation of historical returns …

r

2

¯

– Where r

i

are log periodic returns (usually daily); e.g. r

i

= log(P

i

/P

i – 1

)

Vol Periodic A

N

r

A σ

i

R

× = =

¯

– N is the number of returns in the calculation.

– A is the number of periods in a year (A = 252 for daily data).

“Realized vol” can be different with different choices of the above, especially p y

the periodicity.

Slide 31

32

What was realized volatility?

For the year ended August 31, 2010 we get …

– Daily realized = 18.9%

Weekly realized = 18 4% – Weekly realized = 18.4%

– Monthly realized = 17.4%

Slide 32

33

Question

Is implied volatility the expectation of future realized volatility?

Slide 33

34

Realized vs. Implied

Slide 34

Source: Credit Suisse Equity Derivatives Research/Locus

35

Implied Vol is “More” than Vol

Implied volatility, as the only number you can “change” in the Black-Scholes

Model, embeds all the deviations from the assumptions of the model …

– Skewness (out-of-the-money put vol is usually > otm call vol) ( y p y )

Aka “volatility smiles”

– Kurtosis (“fat tails”).

– Inability to hedge continuously. y g y

– We own options “continuously” but calculate realized vol at a discrete periodicity (you

can buy and sell an option intra-day, making day-to-day realized vol immaterial).

I li d l i “ t i t d” b ll f th b Implied vol is “contaminated” by all of the above.

Slide 35

36

Questions

1. If the 2500 largest realized vol days from the last 50 years were

concatenated into a single 10-year period, what would be the realized vol of

this “wild decade”?

– Answer: ____________

2. What is the realized vol of the past decade (which includes two of the most

volatile markets in history)? volatile markets in history)?

– Answer: ____________

3 What is the a erage long term le el of reali ed ol? 3. What is the average long-term level of realized vol?

– Answer: ____________

Slide 36

37

Answers

1. If the 2500 largest realized vol days from the last 50 years were

concatenated into a single 10-year period, what would be the realized vol of

this “wild decade”?

– Answer: _____29%____

2. What is the realized vol of the past decade (which includes two of the most

volatile markets in history)? volatile markets in history)?

– Answer: _____22%_____

3 What is the a erage long term le el of reali ed ol? 3. What is the average long-term level of realized vol?

– Answer: _____16%_____

Slide 37

38

Pricing on a 29 Vol …

Slide 38

39

Pricing on a 22 Vol …

Slide 39

40

Pricing on a 16 Vol …

Slide 40

41

2005: C3P2-Driven Rise in 10-year Implied Vol

Slide 41

42

10-Year SPX Vol

1999 -------------------------------------------------------------------------- 2006

Slide 42

43

Constant Volatility

As an alternative to the constant vol input to Black-Scholes, it has often been

proposed that volatility be treated as stochastic.

The standard geometric Brownian motion process for a stock price, S, as

assumed by Black-Scholes is …

σSdW μSdt dS +

– Where …

“mu” is the drift (growth rate) of the stock.

σSdW μSdt dS + =

(g )

“sigma” is the (constant) volatility.

“dt” is an increment of time.

“dW” is a random normal process (Weiner Process).

Slide 43

44

Geometric Brownian Motion

We can “view” the equation on the previous slide …

dS/S

μ

(deterministic component)

σ

(random component, which is “normal”)

+

time

dt

Slide 44

45

Stochastic Volatility: Heston Model

Stochastic volatility process …

1 t

SdW σ μSdt dS + =

Now have a time subscript on vol.

Wh ( ll l b f )

2 t

2

t

2

t

dW ησ )dt σ λ(θ dσ + ÷ = The “volatility process”.

– Where (all else as before) …

“lambda” is the mean reversion rate for the variance.

“theta” is the long-run level to which variance reverts.

“eta” is the volatility of variance. y

dW

1

and dW

2

are correlated Weiner Processes.

Heston, S. L., “A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond

and Currency”, The Review of Financial Studies, 1993.

Slide 45

46

Stochastic Vol

With Heston’s model, we can fit the vol skew and account for fat tails.

Closed form solutions exist for plain vanilla European options. p p p

Replication is tricky … no truly risk-neutral portfolio.

Slide 46

47

Slide 47

48

Contact Information

Paul G. Staneski, Ph.D.

Head of Derivatives Solutions & Training

212-325-2935

paul.staneski@credit-suisse.com

Slide 48

**BlackBlack-Scholes or Black Holes?
**

Issues in modeling long-dated options long1 November 2010 N b 1330 – 1415 hrs

Paul Staneski, Ph.D. Credit Suisse Head of Derivatives Solutions & Training

Society of Actuaries Equity-Based Guarantees Conference

New York

1

It’s a Model!

“All models are wrong, some are useful.”

George Box/Gwilym Jenkins

Slide 2

2

Some Issues

The role of Gamma Rho vs. Vega g

– Relative impacts over time

Variance Swaps

– Short-term vs. long-term replication

** Realized vs. Implied Vol
**

– How do you price? – How do you hedge?

Slide 3

3

Slide 4 4 . 2005. y g p p Journal of Political Economy. “The Pricing of Options and Corporate Liabilities”. – Scholes and Robert Merton won the 1997 Nobel Prize in Economics for this work (Black died in 1995 and the prizes are not awarded posthumously). pp.Black-Scholes The “Black-Scholes” model rivals CAPM (the Capital Asset Pricing Model) as the most important result in the history of finance. 637-659. 81 (May-June 1973). Historical note: Ed Thorp actually first derived this result in 1967! – Read “Fortune’s Formula” by William Poundstone. Hill & Wang. – Fischer Black and Myron Scholes.

Black-Scholes in a Nutshell Option ∆Stock (“balance” with financing) Slide 5 5 .

The Greeks are Key! Slide 6 6 .

Delta Hedging & Gamma Value Hedge (Short Stock) Long Call Gain on Hedge Gain on Long Call Loss on Call Loss on Hedge Stock Price Because of gamma the hedged position has a net gain regardless of the move in spot gamma. spot. Slide 7 7 .

Capturing Gamma Hedging & re-hedging a long call … P/L S1 S2 Stock Price Initial Premium Gamma “captured” Slide 8 8 .

Capturing (More) Gamma Hedging & re-hedging a long call … P/L S3 S1 S2 Stock Price Initial Premium Gamma “captured” captured Gamma “captured” Slide 9 9 .

in the “real world” this time invariance is not the case! The “troublesome” assumptions … troublesome Constant interest rates (and dividends) Constant volatility Slide 10 10 . However.Model Assumptions Under all the model’s assumptions (there are many!) the application of the model to a 10-day option is not at all different than its application to a 10-year option.

If realized volatility over the 90 days is 40%.Question Suppose you buy a 90-day Call option on a stock at an implied volatility of 35% and dynamically hedge it (perfectly. will you make money? k ? – Answer: ____________ Slide 11 11 . as per the Black-Scholes assumptions) to expiration.

g p p p you might not. Slide 12 12 . but given the particular price path of the stock p y.Answer Not necessarily! You expect to make money.

Where’s your gamma? These two price paths have exactly the same vol … A B … but gamma is not constant over time. Which one would rather be hedging over? Answer: _________ Slide 13 13 .

05 Gamm ma 0.0 0.0 01 t=1 60 80 100 Spot 120 140 Slide 14 14 .25 0.Gamma and Time X = 100.02 0. vol = 16%.03 0. r = 4% 0.04 t = 0.

long-dated averaging out may not occur. However because many fewer long dated options are traded this “averaging” However.Non-Constant Gamma The “path-dependency” problem induced by non-constant gamma over time is not a serious issue for short-dated options. Slide 15 15 . Large volumes generally ensure that the “expected” nature of hedging profits prevails.

in option value C r chg. Slide 16 16 . in option value C chg.g. – Unit of change in vol is an absolute 1% (e.More Greeks: Vega and Rho The change in an option’s value given a change in volatility is known as vega … Vega chg. The change in an option’s value given a change in rates is known as rho … Rho chg. chg in volatility σ – Also known as tau or kappa.. 25% to 26%). in rates – Unit of change in rates is usually taken to be an absolute 1% (100 bps).

Vega and Rho Question: Why does the put value rise then begin to decline? Slide 17 17 .

Vega vs. Rho over Time Rho increases absolutely with time but vega actually starts to decline … Slide 18 18 .

Vega/Put vs. Rho/Put Rho will eventually exceed the value of the p y put! Slide 19 19 .

Hedging Rho For short-dated options. rho is not a big concern for equity-option traders. For long-dated options. long-dated rate risk is not as easily hedged. as we have seen rho risk becomes significant and this long dated options seen. Slide 20 20 . and especially in this low rate and low rate-vol environment. but is virtually certain over the next 10 years. Rho risk that is generated by trading equity options can be hedged with FRAs and Eurodollar Futures. – A 100 bp change in rates is very unlikely in the next 3 months.

. – What rate to model? Short rate (LIBOR)? Risk-free (e. Treasury)? Ri k f ( T )? Forward rate(s)? – What distributional assumption? Normal? Lognormal? This has lead to a plethora of models.g. Slide 21 21 .Stochastic Interest Rates Interest-rate sensitive derivatives can be priced with a model that allows for the evolution of rates (“stochastic” interest rates) over time. Modelling rates is fundamentally more complex than modelling equities.

More Questions Do rates mean revert? Is vol dependent on the level of rates? p – Are the vols of spot rates and forward rates different? How important is “fitting the market”? – What is to be “fit”? Zero-coupon bond prices? Forward rates? Option prices (caps floors swaptions)? (caps. floors. Slide 22 22 .

calibrated to market prices) or what should be (equilibrium models)? – Equilibrium models: term structure of rates is an output. Models that “fit the market” all suffer from the same problems as BlackScholes: h d i l S h l hedging long-dated i d d instruments i diffi l is difficult. Equilibrium models often yield “unsatisfactory” prices. q p – Market (“no-arbitrage”) models: term structure is an input.Basic Model Structure Is a model a model of what is (that is. Slide 23 23 .

strategies Multi-factor models also exist. Slide 24 24 . but alone do not provide adequate hedging strategies.One-Factor Interest Rate Models All of these models do a reasonable job of pricing.

Slide 25 25 . – Payoff = M*(Realized Variance Strike Variance) M (Realized – The “multiplier” M = notional size of the contract (“Variance Units”) – Really just a Forward. M is chosen to achieve a specific “vega notional” or vega amount (change in value of swap given a 1% change in vol). Note 1: The strike is quoted in vol terms (20%.Variance Swaps Variance Swap: a contract that pays the difference between the realized variance and a fixed level of variance (the “strike”). Note 2: Despite how the strike is quoted. for example) even though the contract is valued as the difference between variances.

Imp. Vol The weights are in inverse proportion to the square of strike. by a weighted portfolio of out-of-the-money (with respect to the Forward) puts and calls.Replicating/Hedging a Variance Swap The payoff of a variance swap is replicated. and hence hedged. Buy all these options … Out-of-the-money Puts F Out-of-the-money Calls Strike Slide 26 26 .

For long-dated swaps. it is clear that a reasonably wide. For short-dated swaps ( < 1 year).Short vs. Slide 27 27 . liquid strip of options is necessary. such options trade with sufficient liquidity on major indices. it is hard to hedge properly and market makers thus try long dated swaps to match buyers with sellers. Long-Dated Variance Swaps Given the replicating portfolio of a variance swap.

Valuing an Option: Inputs In order to value an option. if applicable) Time to expiration (t) (Expected) Volatility ( ) σ S X r t σ Valuation Model (Black-Scholes?) Value Option V l Slide 28 28 . we need to know … – – – – – Spot price (S) Strike Price (X) Interest rates (r) (and dividend yield.

Option Pricing Models ? Models yield values … markets give us prices! Slide 29 29 .

X. r. We can “reverse-engineer” the model to solve for the volatility that would produce this price (along with the other known inputs) … Implied Vol Valuation Model (Black-Scholes) Option Price Slide 30 30 . is the price of an option. however. and t are all observable (and essentially unequivocal).Implied Volatility The “character” of the 5 inputs is different: S. What we can observe in the market. volatility is not.

ri = log(Pi /Pi – 1) – N is the number of returns in the calculation.g. – A is the number of periods in a year (A = 252 for daily data). e. especially p y the periodicity. it is the observed (annualized) standard deviation of historical returns … σR A r N 2 i A Periodic Vol – Where ri are log periodic returns (usually daily). Slide 31 31 . “Realized vol” can be different with different choices of the above.Realized Volatility Realized volatility is a statistical calculation.

2010 we get … – Daily realized = 18.4% Slide 32 32 .What was realized volatility? For the year ended August 31.9% – Weekly realized = 18 4% 18.4% – Monthly realized = 17.

Question Is implied volatility the expectation of future realized volatility? Slide 33 33 .

Implied Source: Credit Suisse Equity Derivatives Research/Locus Slide 34 34 .Realized vs.

I li d voll iis “ t i t d” b all of th above. – Inability to hedge continuously. Implied “contaminated” by ll f the b Slide 35 35 . y g y – We own options “continuously” but calculate realized vol at a discrete periodicity (you can buy and sell an option intra-day. making day-to-day realized vol immaterial).Implied Vol is “More” than Vol Implied volatility. embeds all the deviations from the assumptions of the model … – Skewness (out-of-the-money p vol is usually > otm call vol) ( y put y ) Aka “volatility smiles” – Kurtosis (“fat tails”). as the only number you can “change” in the Black-Scholes Model.

Questions 1. What is the realized vol of the past decade (which includes two of the most volatile markets in history)? – Answer: ____________ 3 What is the a erage long term le el of reali ed vol? 3. If the 2500 largest realized vol days from the last 50 years were concatenated into a single 10-year period. what would be the realized vol of this “wild decade”? – Answer: ____________ 2. average long-term level realized ol? – Answer: ____________ Slide 36 36 .

What is the realized vol of the past decade (which includes two of the most volatile markets in history)? – Answer: _____22%_____ 3 What is the a erage long term le el of reali ed vol? 3. average long-term level realized ol? – Answer: _____16%_____ Slide 37 37 . what would be the realized vol of this “wild decade”? – Answer: _____29%____ 2. If the 2500 largest realized vol days from the last 50 years were concatenated into a single 10-year period.Answers 1.

Pricing on a 29 Vol … Slide 38 38 .

Pricing on a 22 Vol … Slide 39 39 .

Pricing on a 16 Vol … Slide 40 40 .

2005: C3P2-Driven Rise in 10-year Implied Vol Slide 41 41 .

10-Year SPX Vol 1999 -------------------------------------------------------------------------- 2006 Slide 42 42 .

Constant Volatility As an alternative to the constant vol input to Black-Scholes. it has often been proposed that volatility be treated as stochastic. “dW” is a random normal process (Weiner Process). as assumed by Black-Scholes is … dS μSdt σSdW – Where … “mu” is the drift (growth rate) of the stock. (g ) “sigma” is the (constant) volatility. “dt” is an increment of time. The standard geometric Brownian motion process for a stock price. S. Slide 43 43 .

Geometric Brownian Motion We can “view” the equation on the previous slide … dS/S μ σ (deterministic component) + (random component. which is “normal”) time dt Slide 44 44 .

Heston.. “theta” is the long-run level to which variance reverts. L. “eta” is the volatility of variance. dσ 2 λ(θ σ 2 )dt ησ t dW2 t t – Wh (all else as b f ) … Where ( ll l before) The “volatility process”. y dW1 and dW2 are correlated Weiner Processes. “lambda” is the mean reversion rate for the variance. Slide 45 45 . The Review of Financial Studies. S.Stochastic Volatility: Heston Model Stochastic volatility process … dS μSdt σ t SdW1 Now have a time subscript on vol. 1993. “A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency”.

p p p Replication is tricky … no truly risk-neutral portfolio.Stochastic Vol With Heston’s model. Closed form solutions exist for plain vanilla European options. we can fit the vol skew and account for fat tails. Slide 46 46 .

Slide 47 47 .

Contact Information Paul G.staneski@credit-suisse. Ph.com Slide 48 48 . Staneski. Head of Derivatives Solutions & Training 212-325-2935 paul.D.

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