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In informationally efficient financial markets, option prices and this implied volatility should immediately be adjusted to new information that arrives along with a jump in underlying's return, whereas gradual changes in implied volatility…
In this paper we show how to hedge a zero coupon bond with a smaller amount of initial capital than required by the classical risk neutral paradigm, whose (trivial) hedging strategy does not suggest to invest in the risky assets. Long dated…
We propose a robust and stable lattice method which permits to obtain very accurate American option prices in presence of CIR stochastic interest rate without any numerical restriction on its parameters. Numerical results show the…
The objective of this paper is to introduce the theory of option pricing for markets with informed traders within the framework of dynamic asset pricing theory. We introduce new models for option pricing for informed traders in complete…
It is well-known that, in the Bachelier model, when asset prices and volatilities are uncorrelated, the implied volatility coincides with the fair value of the volatility swap. In this paper, via classical It\^o calculus and Taylor…
The crisis that affected financial markets in the last years leaded market practitioners to revise well known basic concepts like the ones of discount factors and forward rates. A single yield curve is not sufficient any longer to describe…
Given a finite set of European call option prices on a single underlying, we want to know when there is a market model which is consistent with these prices. In contrast to previous studies, we allow models where the underlying trades at a…
We consider the pricing of derivatives written on the discretely sampled realized variance of an underlying security. In the literature, the realized variance is usually approximated by its continuous-time limit, the quadratic variation of…
With the reform of interest rate benchmarks, interbank offered rates (IBORs) like LIBOR have been replaced by risk-free rates (RFRs), such as the Secured Overnight Financing Rate (SOFR) in the U.S. and the Euro Short-Term Rate (\euro STR)…
We develop a theory for option pricing with perfect hedging in an inefficient market model where the underlying price variations are autocorrelated over a time tau. This is accomplished by assuming that the underlying noise in the system is…
We introduce a discrete binary tree for pricing contingent claims with the underlying security prices exhibiting history dependence characteristic of that induced by market microstructure phenomena. Example dependencies considered include…
This paper examines the degree of integration at euro area financial markets. To that end, we estimate overall and country-specific integration indices based on a panel vector-autoregression with factor stochastic volatility. Our results…
Risk-neutral default probabilities can be implied from credit default swap (CDS) market quotes. In practice, mid CDS quotes are used as inputs, as their risk-neutral counterparts are not observable. We show how to imply risk-neutral default…
Put-call parity is a terminal-payoff identity, but its enforcement is capital-using. I study the carry gap, the annualized wedge between option-implied and OIS discount factors, in SPX and RUT index options. Quoted parity is tightly…
The main result of this paper that a martingale evolution can be chosen for Libor such that all the Libor interest rates have a common market measure; the drift is fixed such that each Libor has the martingale property. Libor is described…
We investigate the relation between the fair price for European-style vanilla options and the distribution of short-term returns on the underlying asset ignoring transaction and other costs. We compute the risk-neutral probability density…
Catastrophe (CAT) bond markets are incomplete and hence carry uncertainty in instrument pricing. As such various pricing approaches have been proposed, but none treat the uncertainty in catastrophe occurrences and interest rates in a…
At present, there is an explosion of practical interest in the pricing of interest rate (IR) derivatives. Textbook pricing methods do not take into account the leptokurticity of the underlying IR process. In this paper, such a leptokurtic…
We consider a financial market in which the short rate is modeled by a continuous time Markov chain (CTMC) with a finite state space. In this setting, we show how to price any financial derivative whose payoff is a function of the state of…
We provide a general and flexible approach to LIBOR modeling based on the class of affine factor processes. Our approach respects the basic economic requirement that LIBOR rates are non-negative, and the basic requirement from mathematical…