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Calibrating The Smile With Multivariate Time-Changed Brownian Motion And The Esscher Transform

Author

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  • GIAN LUCA TASSINARI

    (Department of Mathematics, Alma Mater Studiorum, University of Bologna, Piazza di Porta San Donato, 5, 40126, Bologna, Italy)

  • MICHELE LEONARDO BIANCHI

    (Regulation and Macroprudential Analysis Department, Bank of Italy, Via Milano 53, 00184, Rome, Italy)

Abstract

In this study, we investigate two multivariate time-changed Brownian motion option pricing models in which the connection between the historical measure P and the risk-neutral measure Q is given by the Esscher transform. The models incorporate skewness, kurtosis and more complex dependence structures among stocks log-returns than the simple correlation matrix. The two models can be seen as a multivariate extension of the normal inverse Gaussian (NIG) model and the variance gamma (VG) model, respectively. We discuss two possible approaches to estimate historical asset returns and calibrate univariate option implied volatilities. While the first approach considers only time series of log-returns, the second approach makes use of both time series of log-returns and univariate observed volatility surfaces. To calibrate the models, there is no need of liquid multivariate derivative quotes.

Suggested Citation

  • Gian Luca Tassinari & Michele Leonardo Bianchi, 2014. "Calibrating The Smile With Multivariate Time-Changed Brownian Motion And The Esscher Transform," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 17(04), pages 1-34.
    • Handle: RePEc:wsi:ijtafx:v:17:y:2014:i:04:n:s021902491450023x
    DOI: 10.1142/S021902491450023X
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    References listed on IDEAS

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    1. Florence Guillaume, 2013. "The αVG model for multivariate asset pricing: calibration and extension," Review of Derivatives Research, Springer, vol. 16(1), pages 25-52, April.
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    7. Michele Leonardo Bianchi & Svetlozar T. Rachev & Frank J. Fabozzi, 2018. "Calibrating the Italian Smile with Time-Varying Volatility and Heavy-Tailed Models," Computational Economics, Springer;Society for Computational Economics, vol. 51(3), pages 339-378, March.
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    Cited by:

    1. Michele Leonardo Bianchi & Svetlozar T. Rachev & Frank J. Fabozzi, 2018. "Calibrating the Italian Smile with Time-Varying Volatility and Heavy-Tailed Models," Computational Economics, Springer;Society for Computational Economics, vol. 51(3), pages 339-378, March.
    2. Hasan Fallahgoul & Gregoire Loeper, 2021. "Modelling tail risk with tempered stable distributions: an overview," Annals of Operations Research, Springer, vol. 299(1), pages 1253-1280, April.
    3. Michele Leonardo Bianchi & Gian Luca Tassinari, 2018. "Forward-looking portfolio selection with multivariate non-Gaussian models and the Esscher transform," Papers 1805.05584, arXiv.org, revised May 2018.
    4. Michele Leonardo Bianchi & Asmerilda Hitaj & Gian Luca Tassinari, 2020. "Multivariate non-Gaussian models for financial applications," Papers 2005.06390, arXiv.org.
    5. Hasan A. Fallahgoul & Young S. Kim & Frank J. Fabozzi & Jiho Park, 2019. "Quanto Option Pricing with Lévy Models," Computational Economics, Springer;Society for Computational Economics, vol. 53(3), pages 1279-1308, March.
    6. Michele Leonardo Bianchi, 2018. "Are multi-factor Gaussian term structure models still useful? An empirical analysis on Italian BTPs," Papers 1805.09996, arXiv.org.
    7. Michele Leonardo Bianchi & Gian Luca Tassinari & Frank J. Fabozzi, 2016. "Riding With The Four Horsemen And The Multivariate Normal Tempered Stable Model," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(04), pages 1-28, June.
    8. Massimo Arnone & Michele Leonardo Bianchi & Anna Grazia Quaranta & Gian Luca Tassinari, 2021. "Catastrophic risks and the pricing of catastrophe equity put options," Computational Management Science, Springer, vol. 18(2), pages 213-237, June.

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