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

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Author Info

  • Dominique Guegan

    ()
    (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)

  • Jing Zhang

    (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, ECNU - East China Normal University [Shangaï])

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

Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00368336.

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Date of creation: Oct 2009
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Publication status: Published, European Journal of Finance, 2009, 15, 7-8, 777-795
Handle: RePEc:hal:cesptp:halshs-00368336

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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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Cited by:
  1. Dominique Guegan & Jing Zhang, 2006. "Change analysis of dynamic copula for measuring dependence in multivariate financial data," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers), HAL halshs-00189141, HAL.
  2. Cyril Caillault, Dominique Guégan, 2009. "Forecasting VaR and Expected Shortfall Using Dynamical Systems: A Risk Management Strategy," Frontiers in Finance and Economics, SKEMA Business School, SKEMA Business School, vol. 6(1), pages 26-50, April.

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