Modeling and simulation of financial returns under non-Gaussian distributions

DOI10.1016/J.PHYSA.2023.128886MaRDI QIDQ6156468FDO

Authors Federica De Domenico, Giacomo Livan, Guido Montagna, Oreste Nicrosini

Publication date 13 June 2023

Published in Physica A (Search for Journal in Brave)

Full work available at URL https://arxiv.org/abs/2302.02769

zbMATH Keywords

option pricingstochastic processeseconophysicsheavy-tailed distributionsMonte Carlo simulationsfinancial returns

Mathematics Subject Classification ID

Statistical mechanics, structure of matter (82-XX)

Abstract: It is well known that the probability distribution of high-frequency financial returns is characterized by a leptokurtic, heavy-tailed shape. This behavior undermines the typical assumption of Gaussian log-returns behind the standard approach to risk management and option pricing. Yet, there is no consensus on what class of probability distributions should be adopted to describe financial returns and different models used in the literature have demonstrated, to varying extent, an ability to reproduce empirically observed stylized facts. In order to provide some clarity, in this paper we perform a thorough study of the most popular models of return distributions as obtained in the empirical analyses of high-frequency financial data. We compare the statistical properties and simulate the dynamics of non-Gaussian financial fluctuations by means of Monte Carlo sampling from the different models in terms of realistic tail exponents. Our findings show a noticeable consistency between the considered return distributions in the modeling of the scaling properties of large price changes. We also discuss the convergence rate to the asymptotic distributions of the non-Gaussian stochastic processes and we study, as a first example of possible applications, the impact of our results on option pricing in comparison with the standard Black and Scholes approach.

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