Title: The valuation of structured products using Markov chain models
Authors: Madan, Dilip ×
Pistorius, Martijn
Schoutens, Wim #
Issue Date: 2013
Publisher: Institute of Physics Pub. Ltd., in association with American Institute of Physics
Series Title: Quantitative Finance vol:13 pages:125-136
Abstract: A Markov chain with an expanding non-uniform grid matching risk-neutral marginal distributions is constructed. Conditional distributions of the chain are in the variance gamma class with pre-specified skewness and excess kurtosis. Time change and space scale volatilities are calibrated from option data. For Markov chains, dynamically consistent sequences of bid and ask prices are developed by applying the theory of nonlinear expectations with drivers given by concave distortions applied to the one-step-ahead risk. The procedures are illustrated by generating dynamically consistent bid ask sequences for a variety of structured products, such as locally capped and floored cliquets, rolling calls and puts and hedged and unhedged variance swap contracts. Two-sided nonlinear barrier pricing of straddles is also accomplished. All methods are illustrated on the surface of JPM on October 15, 2009.
ISSN: 1469-7688
Publication status: published
KU Leuven publication type: IT
Appears in Collections:Statistics Section
× corresponding author
# (joint) last author

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