Coupling index and stocks

DOI10.1080/14697681003785959zbMATH Open1278.91113arXiv0911.2834OpenAlexW2163723725MaRDI QIDQ2869971FDOQ2869971

Mohamed Sbai, Benjamin Jourdain

Publication date: 17 January 2014

Published in: Quantitative Finance (Search for Journal in Brave)

Abstract: In this paper, we are interested in continuous time models in which the index level induces some feedback on the dynamics of its composing stocks. More precisely, we propose a model in which the log-returns of each stock may be decomposed into a systemic part proportional to the log-returns of the index plus an idiosyncratic part. We show that, when the number of stocks in the index is large, this model may be approximated by a local volatility model for the index and a stochastic volatility model for each stock with volatility driven by the index. This result is useful in a calibration perspective : it suggests that one should first calibrate the local volatility of the index and then calibrate the dynamics of each stock. We explain how to do so in the limiting simplified model and in the original model.

Full work available at URL: https://arxiv.org/abs/0911.2834

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zbMATH Keywords

Monte Carlo methodsnumerical simulationstochastic volatilitymodel calibrationequitiesimplied volatilitiescorrelation modelling

Mathematics Subject Classification ID

Statistical methods; economic indices and measures (91B82) Numerical methods (including Monte Carlo methods) (91G60) Stochastic models in economics (91B70)

Cites Work

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Cited In (6)

• Equity correlations implied by index options: estimation and model uncertainty analysis
• The multivariate Variance Gamma model: basket option pricing and calibration
• Stochastic local intensity loss models with interacting particle systems
• A model-free approach to multivariate option pricing
• THE HESTON STOCHASTIC-LOCAL VOLATILITY MODEL: EFFICIENT MONTE CARLO SIMULATION
• Implied Volatility of Basket Options at Extreme Strikes

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