An Equity-Interest Rate Hybrid Model With Stochastic Volatility and the Interest Rate Smile Report as inadecuate




An Equity-Interest Rate Hybrid Model With Stochastic Volatility and the Interest Rate Smile - Download this document for free, or read online. Document in PDF available to download.

Abstract

We define an equity-interest rate hybrid model in which the equity part is driven by the Heston stochastic volatility Hes93, and the interest rate IR is generated by the displaced-diffusion stochastic volatility Libor Market Model AA02. We assume a non-zero correlation between the main processes. By an appropriate change of measure the dimension of the corresponding pricing PDE can be greatly reduced. We place by a number of approximations the model in the class of affine processes DPS00, for which we then provide the corresponding forward characteristic function. We discuss in detail the accuracy of the approximations and the efficient calibration. Finally, by experiments, we show the effect of the correlations and interest rate smile-skew on typical equity-interest rate hybrid product prices. For a whole strip of strikes this approximate hybrid model can be evaluated for equity plain vanilla options in just milliseconds.



Item Type: MPRA Paper -

Original Title: An Equity-Interest Rate Hybrid Model With Stochastic Volatility and the Interest Rate Smile-

Language: English-

Keywords: hybrid models; Heston equity model; Libor Market Model with stochastic volatility; displaced diffusion; affine diffusion; fast calibration.-

Subjects: G - Financial Economics > G1 - General Financial MarketsF - International Economics > F3 - International FinanceG - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing-





Author: Grzelak, Lech

Source: https://mpra.ub.uni-muenchen.de/20574/







Related documents