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Change of Numeraire

In: Derivative Security Pricing

Author

Listed:
  • Carl Chiarella

    (University of Technology Sydney)

  • Xue-Zhong He

    (University of Technology Sydney)

  • Christina Sklibosios Nikitopoulos

    (University of Technology Sydney)

Abstract

Many computational applications of derivative pricing models such as the determination of derivative prices by simulation or the estimation of derivative pricing models can be significantly simplified by a change of numeraire. In this chapter we discuss the main idea behind the change of numeraire technique and the formation of equivalent probability measures under which options can be priced. In addition, the connection of the associated numeraires via the Radon–Nikodym derivative are presented. We also consider an application of the technique for the option pricing models with stochastic interest rate discussed in Chap. 19 and an extension of the technique to accommodate multiple sources of risk in the dynamics of the underlying assets is also considered.

Suggested Citation

  • Carl Chiarella & Xue-Zhong He & Christina Sklibosios Nikitopoulos, 2015. "Change of Numeraire," Dynamic Modeling and Econometrics in Economics and Finance, in: Derivative Security Pricing, edition 127, chapter 0, pages 419-430, Springer.
    • Handle: RePEc:spr:dymchp:978-3-662-45906-5_20
    DOI: 10.1007/978-3-662-45906-5_20
    as

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