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Managing financial risk in Chinese stock markets: Option pricing and modeling under a multivariate threshold autoregression

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  • Li, Johnny Siu-Hang
  • Ng, Andrew C.Y.
  • Chan, Wai-Sum

Abstract

The Shanghai Stock Exchange and the Shenzhen Stock Exchange have grown remarkably since their inception 20years ago. Many of the investors in these two markets are asset management firms or pension funds, some of which may offer guaranteed returns to their clients. To these investors, modeling and managing the risk associated with their equity investments are highly important. In this paper, we use a multivariate threshold autoregressive (TAR) process to model the non-linear relationship between the two markets. This model may help fund managers better plan or execute their risk management decisions, as it captures the difference in investment return behavior when one market significantly out- or under-performs the other. We also contribute a risk-neutral version of the multivariate TAR model to the literature. This contribution permits one to price exotic options written on multiple stock indexes, and consequently helps fund managers calculate the cost of an option-based risk management strategy for funds involving the two Chinese markets.

Suggested Citation

  • Li, Johnny Siu-Hang & Ng, Andrew C.Y. & Chan, Wai-Sum, 2015. "Managing financial risk in Chinese stock markets: Option pricing and modeling under a multivariate threshold autoregression," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 217-230.
  • Handle: RePEc:eee:reveco:v:40:y:2015:i:c:p:217-230
    DOI: 10.1016/j.iref.2015.02.022
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    References listed on IDEAS

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    Cited by:

    1. Hammoudeh, Shawkat & McAleer, Michael, 2015. "Advances in financial risk management and economic policy uncertainty: An overview," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 1-7.
    2. Siu, Tak Kuen, 2016. "A self-exciting threshold jump–diffusion model for option valuation," Insurance: Mathematics and Economics, Elsevier, vol. 69(C), pages 168-193.

    More about this item

    Keywords

    Threshold autoregression; Risk-neutral valuation; Multivariate time-series;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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