A simple time-consistent model for the forward density process

DOI10.1142/S0219024913500489MaRDI QIDQ5411745zbMATH OpenFDO

Authors Henrik Hult, Filip Lindskog, Johan Nykvist

Publication date 25 April 2014

Published in International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/1301.4869

zbMATH Keywords

mixture modelsoption pricing

Mathematics Subject Classification ID

Martingales with continuous parameter (60G44) Applications of stochastic analysis (to PDEs, etc.) (60H30) Derivative securities (option pricing, hedging, etc.) (91G20)

Abstract: In this paper a simple model for the evolution of the forward density of the future value of an asset is proposed. The model allows for a straightforward initial calibration to option prices and has dynamics that are consistent with empirical findings from option price data. The model is constructed with the aim of being both simple and realistic, and avoid the need for frequent re-calibration. The model prices of $n$ options and a forward contract are expressed as time-varying functions of an $(n+1)$-dimensional Brownian motion and it is investigated how the Brownian trajectory can be determined from the trajectories of the price processes. An approach based on particle filtering is presented for determining the location of the driving Brownian motion from option prices observed in discrete time. A simulation study and an empirical study of call options on the S&P 500 index illustrates that the model provides a good fit to option price data.

Recommendations

• Sequential calibration of options
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Cites work

• Arbitrage-free market models for option prices: the multi-strike case
• CONDITIONAL DENSITY MODELS FOR ASSET PRICING
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• THE RANGE OF TRADED OPTION PRICES

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