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Joint Characteristic Function of Stock Log-Price and Squared Volatility in the Bates Model and Its Asset Pricing Applications

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  • Zhylyevskyy, Oleksandr

Abstract

The model of Bates specifies a rich, flexible structure of stock dynamics suitable for applications in finance and economics, including valuation of derivative securities. This paper analytically derives a closed-form expression for the joint conditional characteristic function of a stock's log-price and squared volatility under the model dynamics. The use of the function, based on inverting it, is illustrated on examples of pricing European-, Bermudan-, and American-style options. The discussed approach for European-style derivatives improves on the option formula of Bates. The suggested approach for American-style derivatives, based on a compound-option technique, offers an alternative solution to existing finite-difference methods.

Suggested Citation

  • Zhylyevskyy, Oleksandr, 2012. "Joint Characteristic Function of Stock Log-Price and Squared Volatility in the Bates Model and Its Asset Pricing Applications," Staff General Research Papers Archive 35559, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genres:35559
    DOI: 10.4236/tel.2012.24074
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    References listed on IDEAS

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