Review of Derivatives Research

Publisher: Springer Verlag


The proliferation of derivative assets during the past two decades is unprecedented. With this growth in derivatives comes the need for financial institutions institutional investors and corporations to use sophisticated quantitative techniques to take full advantage of the spectrum of these new financial instruments. Academic research has significantly contributed to our understanding of derivative assets and markets. The growth of derivative asset markets has been accompanied by a commensurate growth in the volume of scientific research. The rapid growth of derivatives research combined with the current absence of a rigorous research journal catering to the area of derivatives and the long lead-times in the existing academic journals underlines the need for Review of Derivatives Research which provides an international forum for researchers involved in the general areas of derivative assets. The Review publishes high quality articles dealing with the pricing and hedging of derivative assets on any underlying asset (commodity interest rate currency equity real estate traded or non-traded etc.). Specific topics include but are not limited to: econometric analyses of derivative markets (efficiency anomalies performance etc.) analysis of swap markets market microstructure and volatility issues regulatory and taxation issues credit risk new areas of applications such as corporate finance (capital budgeting debt innovations) international trade (tariffs and quotas) banking and insurance (embedded options asset-liability management) risk-sharing issues and the design of optimal derivative securities risk management management and control valuation and analysis of the options embedded in capital projects valuation and hedging of exotic options new areas for further development (i.e. natural resources environmental economics. The Review has a double-blind refereeing process. In contrast to the delays in the decision making and publication processes of many current journals the Review will provide authors with an initial decision within nine weeks of receipt of the manuscript and a goal of publication within six months after acceptance. Finally a section of the journal is available for rapid publication on 'hot' issues in the market small technical pieces and timely essays related to pending legislation and policy.

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    Review of Derivatives Research website
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    Review of derivatives research (Online)
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    Document, Periodical, Internet resource
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    Internet Resource, Computer File, Journal / Magazine / Newspaper

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Springer Verlag

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Publications in this journal

  • [Show abstract] [Hide abstract]
    ABSTRACT: The game option, which is also known as Israel option, is an American option with callable features. The option holder can exercise the option at any time up to maturity. This article studies the pricing behaviors of the path-dependent game option where the payoff of the option depends on the maximum or minimum asset price over the life of the option (i.e., the game option with the lookback feature). We obtain the explicit pricing formula for the perpetual case and provide the integral expression of pricing formula under the finite horizon case. In addition, we derive optimal exercise strategies and continuation regions of options in both floating and fixed strike cases.
    Review of Derivatives Research 01/2014;
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    ABSTRACT: This paper proposes a way to quantify expected profits and risk to model based trading strategies. A positive portfolio weight is assigned to assets which market prices exceed the price of a theoretical asset pricing model. The position is smaller, ceteris paribus, if the theoretical asset price is sensitive to model parameters subject to estimation uncertainty. Standard mean-variance analysis is used to construct optimal model based portfolio weights. In essence, these portfolio rules allow estimation risk, as well as price risk to be approximately hedged. The strategy is applied to S&P 500 index options. The model based hedging strategy generate Sharpe ratios close to one -twice that of simply writing options. The difference is still only marginally statistically significant.. I wish to thank Tim Bollerslev and George Tauchen, as well as seminar participants in the Duke Financial Econometrics workshop, for helpful comments. The usual disclaimer applies.
    Review of Derivatives Research 01/2013; 16(1).
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    ABSTRACT: This paper discusses various extensions and implementation aspects of the primal-dual algorithm of Andersen and Broadie for the pricing of Bermudan options. The main emphasis is on a generalization of the dual lower and upper bounds to the case of mixed buyer and seller exercise, along with a detailed analysis of the sharpness of the bounds. As it turns out, the method as well as the convergence analysis can even be extended to conditional exercise rights and autotrigger strategies. These theoretical results are accompanied by a detailed description of the algorithmic implementation, including a robust regression method and the choice of suitable basis functions. Detailed numerical examples show that the algorithm leads to surprisingly tight bounds even for the case of high-dimensional callable Bermudan pricing problems.
    Review of Derivatives Research 01/2013; 16(1).
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    ABSTRACT: Arbitrage-free pricing of American options on bonds in one-factor dynamic term structure models is investigated. We re-derive a general decomposition result which states that the American bond option premium can be split into the value of an otherwise equivalent European option and an early exercise premium. This extends earlier work on American equity options by e.g. Kim (1990), Jamshidian (1992) and Carr, Jarrow, and Myneni (1992) and parallels recent work by Jamshidian (1991, 1992, 1993) and Chesney, Elliott, and Gibson (1993). We examine a Gaussian class of special cases in some detail and provide a variety of numerical valuation results.
    Review of Derivatives Research 12/2012;
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    ABSTRACT: This paper studies capital adequacy rules based on Value-at-Risk (VaR), leverage ratios, and stress testing. VaR is the basis of Basel II, and all three approaches are proposed in Basel III. This paper makes three contributions to the literature. First, we prove that these three rules provide an incentive to increase the probability of catastrophic financial institution failure. Collectively, these rules provide an incentive to increase (not decrease) systemic risk. Second, we argue that an unintended consequence of the Basel II VaR capital adequacy rules was the 2007 credit crisis. Third, we argue that to reduce systemic risk, a new capital adequacy rule is needed. One that is based on a risk measure related to the conditional expected loss given insolvency.
    Review of Derivatives Research 06/2012;
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    ABSTRACT: We review recent European warrant pricing theory that accounts for other securities in the capital structure of the firm, besides the stock and a warrant. An individual who owns a European warrant determines his exercise policy in equilibrium taking into account any transfer of wealth between stockholders and holders of other non-expiring securities. As a result, the equilibrium exercise policy differs from the textbook call-like policy. The equilibrium exercise policy depends on the direction of wealth transfer. We derive the competitive equilibrium policy and demonstrate how it can be computed.
    Review of Derivatives Research 01/2012; 15(2).
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    ABSTRACT: Compound options are not only sensitive to future movements of the underlying asset price, but also to future changes in volatility levels. Because the Black-Scholes analytical valuation formula for compound options is not able to incorporate the sensitivity to volatility, the aim of this paper is to develop a numerical pricing procedure for this type of option in stochastic volatility models, specifically focusing on the model of Heston.For this, the compound option value is represented as the difference of its exercise probabilities, which depend on three random variables through a complex functional form. Then the joint distribution of these random variables is uniquely determined by their characteristic function and therefore the probabilities can each be expressed as a multiple inverse Fourier transform. Solving the inverse Fourier transform with respect to volatility, we can reduce the pricing problem from three to two dimensions. This reduced dimensionality simplifes the application of the fast Fourier transform method developed by Dempster and Hong when transfered to our stochastic volatility framework. After combining their approach with a new extension of the fractional fast Fourier transform technique for option pricing to the two-dimensional case, it is possible to obtain good approximations to the exercise probabilities. The resulting upper and lower bounds are then compared with other numerical methods such as Monte Carlo simulations and show promising results.
    Review of Derivatives Research 10/2011;
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    ABSTRACT: In this paper, we propose a parametric model of implied variance which is a natural generalization of the SVI model. The model improves the SVI by allowing more flexibly the negative curvature in the tails which is justified both theoretically and empirically. The fitting of the model, comparing with the other competing parametric models (SVI, SABR), to the implied volatility smile and the risk neutral density function is tested on SPX options.
    Review of Derivatives Research 08/2011; 16(1).
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    ABSTRACT: This paper presents an approximate formula for pricing average options when the underlying asset price is driven by time-changed Levy processes. Time-changed Levy processes are attractive to use for a driving factor of underlying prices because the processes provide a flexible framework for generating jumps, capturing stochastic volatility as the random time change, and introducing the leverage effect. There have been very few studies dealing with pricing problems of exotic derivatives on time-changed Levy processes in contrast to standard European derivatives. Our pricing formula is based on the Gram-Charlier expansion and the key of the formula is to find analytic treatments for computing the moments of the normalized average asset price. In numerical examples, we demonstrate that our formula give accurate values of average call options when adopting Heston's stochastic volatility model, VG-CIR, and NIG-CIR models.
    Review of Derivatives Research 07/2011;
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    ABSTRACT: This paper determines the value of asset tradeability in an option pricing framework. In our model, tradeability is valuable since it allows investors to exploit temporary mis-pricings of stocks. The model delivers several novel insights on the value of tradeability: The value of tradeability is the larger, the higher the pricing efficiency of the market is. Uncertainty increases the value of tradeablity, no matter whether the uncertainty results from noise trading or from new information about the fundamental value of the stock. The value of tradeability is the larger, the longer the illiquid stock cannot be traded and the more trading dates the liquid stock offers.
    Review of Derivatives Research 07/2011;
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    ABSTRACT: Kuznetsov (Ann Appl Prob, 2009) introduces a 10-parameter family of Lévy processes for which the Wiener-Hopf factors and the distribution of the running supremum (infimum) can be determined semi-analytically. In this text we will examine the numerical performance of this so-called β-family, both in the equity world and in the field of credit risk. In order to do this, we will calibrate a particular member of this family to a vanilla option surface (by means of the Fast Fourier Transform-technique due to Carr and Madan (J Comput Fin 2(4):61–73, 1999) and use the resulting parameters to determine the prices of a digital down-and-out barrier (DDOB) option, written on the same underlying. In a second experiment, we will try and calibrate the model to some real-life credit default swap (CDS) term structures. The parameters of the model under investigation are chosen such that its Lévy density is approximately equal to that of the famous Variance Gamma (VG) process, which will serve as a benchmark. Hence, the former will be referred to as the β-VG model. The option prices will be determined both semi-analytically [using the formulas derived by Kuznetsov (Ann Appl Prob, 2009)] and through a Monte-Carlo simulation. However, the CDS spreads will only be determined semi-analytically, due to the very close relation between pricing DDOB options and determining the par spread of a CDS. Furthermore, in both cases, the results will be compared with the ones obtained using the VG model [Cf. Schoutens (Lévy processes in finance: pricing financial derivatives, Wiley , Chichester, 2003) and, Cariboni and Schoutens (Levy processes in credit risk, Wiley, Chichester, 2009)]. It will turn out that, w.r.t. vanilla option prices, the β-VG model performs almost identically as the VG model, whereas the semi-analytical expressions by Kuznetsov (Ann Appl Prob, 2009) lead to a (fast and) accurate pricing of DDOB options and CDSs. KeywordsLevy processes–Hitting probability–Barrier options
    Review of Derivatives Research 01/2011; 14(3):263-282.

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