By Anatoliy Swishchuk
This ebook is dedicated to the background of switch of Time equipment (CTM), the connections of CTM to stochastic volatilities and finance, primary points of the idea of CTM, simple techniques, and its houses. An emphasis is given on many functions of CTM in monetary and effort markets, and the provided numerical examples are according to actual facts. The swap of time strategy is utilized to derive the well known Black-Scholes formulation for ecu name suggestions, and to derive an specific choice pricing formulation for a eu name alternative for a mean-reverting version for commodity costs. particular formulation also are derived for variance and volatility swaps for monetary markets with a stochastic volatility following a classical and not on time Heston version. The CTM is utilized to cost monetary and effort derivatives for one-factor and multi-factor alpha-stable Levy-based models.
Readers must have a simple wisdom of likelihood and information, and a few familiarity with stochastic methods, corresponding to Brownian movement, Levy approach and martingale.
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Extra info for Change of Time Methods in Quantitative Finance
Demeterfi et al. (1999) explained the properties and the theory of both variance and volatility swaps. They derived an analytical formula for theoretical fair value in the presence of realistic volatility skews and pointed out that volatility swaps can be replicated by dynamically trading the more straightforward variance swap. Javaheri et al. (2002) discussed the valuation and hedging of a GARCH(1,1) stochastic volatility model. They used a general and exible PDE approach to determine the first two moments of the realized variance in a continuous or discrete context.
0 We also remark that W (t) = t 0 t a−1 (X(s))dW˜ (Tˆs ) = 0 a−1 (X(0) + W˜ (Tˆs )))dW˜ (Tˆs ) and X(t) = X(0) + t 0 a(X(s))dW (s). 3 One-Factor Diffusion Models and Their Solutions Using CTM In this section, we introduce well-known one-factor diffusion models (used in finance) described by SDEs and driven by a Brownian motion (so-called Gaussian models). For one-factor Gaussian models, we define the following well-known processes: 1. 2. 3. 4. 5. 6. 7. 8. The geometric Brownian motion: dS(t) = μ S(t)dt + σ S(t)dW (t); The continuous-time GARCH process: dS(t) = μ (b − S(t))dt + σ S(t)dW (t); The Ornstein-Uhlenbeck (1930) process: dS(t) = −μ S(t)dt + σ dW (t); The Vasi´cek (1977) process: dS(t) = μ (b − S(t))dt + σ dW (t); The Cox et al.
2005). 2. The fact that stochastic volatility models, such as the Heston model and others, are able to fit skews and smiles, while simultaneously providing sensible Greeks, has made these models a popular choice in the pricing of options and swaps. Some ideas of how to calculate the Greeks for volatility contracts may be found in Howison et al. (2004). 3. We note that the change of time method was used in Swishchuk and Kalemanova (2000) to study stochastic stability of interest rates with and without jumps, in Swishchuk (2004) to model and to price variance and volatility swaps for the Heston model and in Swishchuk (2005) to price European call options for commodity prices that follow mean-reverting model.