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Pricing bivariate option under GARCH-GH model with dynamic copula: application for Chinese market

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  • Dominique Guegan
  • Jing Zang

Abstract

This paper develops the method for pricing bivariate contingent claims under general autoregressive conditionally heteroskedastic (GARCH) process. In order to provide a general framework being able to accommodate skewness, leptokurtosis, fat tails as well as the time-varying volatility that are often found in financial data, generalized hyperbolic (GH) distribution is used for innovations. As the association between the underlying assets may vary over time, the dynamic copula approach is considered. Therefore, the proposed method proves to play an important role in pricing bivariate option. The approach is illustrated for Chinese market with one type of better-of-two markets claims: call option on the better performer of Shanghai Stock Composite Index and Shenzhen Stock Composite Index. Results show that the option prices obtained by the GARCH-GH model with time-varying copula differ substantially from the prices implied by the GARCH-Gaussian dynamic copula model. Moreover, the empirical work displays the advantage of the suggested method.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

Volume (Year): 15 (2009)
Issue (Month): 7-8 ()
Pages: 777-795

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Handle: RePEc:taf:eurjfi:v:15:y:2009:i:7-8:p:777-795

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Keywords: call-on-max option; GARCH process; generalized hyperbolic (GH) distribution; normal inverse Gaussian (NIG) distribution; copula; dynamic copula;

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References

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  1. Dominique Guegan & Jing Zhang, 2010. "Change analysis of a dynamic copula for measuring dependence in multivariate financial data," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00368334, HAL.
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Cited by:
  1. Dominique Guégan & Jing Zhang, 2006. "Change analysis of dynamic copula for measuring dependence in multivariate financial data," Cahiers de la Maison des Sciences Economiques b06090, Université Panthéon-Sorbonne (Paris 1).
  2. Cyril Caillault & Dominique Guegan, 2009. "Forecasting VaR and Expected Shortfall using Dynamical Systems: A Risk Management Strategy," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00375765, HAL.

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