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Spectral calibration of exponential Lévy Models [2]

Author

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  • Denis Belomestny
  • Markus Reiß

Abstract

The calibration of financial models has become rather important topic in recent years mainly because of the need to price increasingly complex options in a consistent way. The choice of the underlying model is crucial for the good performance of any calibration procedure. Recent empirical evidences suggest that more complex models taking into account such phenomenons as jumps in the stock prices, smiles in implied volatilities and so on should be considered. Among most popular such models are Levy ones which are on the one hand able to produce complex behavior of the stock time series including jumps, heavy tails and on other hand remain tractable with respect to option pricing. The work on calibration methods for financial models based on Lévy processes has mainly focused on certain parametrisations of the underlying Lévy process with the notable exception of Cont and Tankov (2004). Since the characteristic triplet of a Lévy process is a priori an infinite-dimensional object, the parametric approach is always exposed to the problem of misspecification, in particular when there is no inherent economic foundation of the parameters and they are only used to generate different shapes of possible jump distributions. In this work we propose and test a non-parametric calibration algorithm which is based on the inversion of the explicit pricing formula via Fourier transforms and a regularisation in the spectral domain. Using the Fast Fourier Transformation, the procedure is fast, easy to implement and yields good results in simulations in view of the severe ill-posedness of the underlying inverse problem.

Suggested Citation

  • Denis Belomestny & Markus Reiß, 2006. "Spectral calibration of exponential Lévy Models [2]," SFB 649 Discussion Papers SFB649DP2006-035, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  • Handle: RePEc:hum:wpaper:sfb649dp2006-035
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    References listed on IDEAS

    as
    1. Ait-Sahalia, Yacine & Duarte, Jefferson, 2003. "Nonparametric option pricing under shape restrictions," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 9-47.
    2. Rama Cont & Ekaterina Voltchkova, 2005. "Integro-differential equations for option prices in exponential Lévy models," Finance and Stochastics, Springer, vol. 9(3), pages 299-325, July.
    3. Susanne Emmer & Claudia Klüppelberg, 2004. "Optimal portfolios when stock prices follow an exponential Lévy process," Finance and Stochastics, Springer, vol. 8(1), pages 17-44, January.
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    Citations

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    Cited by:

    1. Denis Belomestny & John Schoenmakers, 2010. "A jump-diffusion Libor model and its robust calibration," Quantitative Finance, Taylor & Francis Journals, vol. 11(4), pages 529-546.
    2. Trabs, Mathias, 2014. "On infinitely divisible distributions with polynomially decaying characteristic functions," Statistics & Probability Letters, Elsevier, vol. 94(C), pages 56-62.
    3. Johanna Kappus & Markus Reiß, 2010. "Estimation of the characteristics of a Lévy process observed at arbitrary frequency," Statistica Neerlandica, Netherlands Society for Statistics and Operations Research, vol. 64(s1), pages 314-328.
    4. Belomestny Denis & Mathew Stanley & Schoenmakers John, 2009. "Multiple stochastic volatility extension of the Libor market model and its implementation," Monte Carlo Methods and Applications, De Gruyter, vol. 15(4), pages 285-310, January.
    5. Jacob Söhl & Mathias Trabs, 2012. "Option calibration of exponential Lévy models: Implementation and empirical results," SFB 649 Discussion Papers SFB649DP2012-017, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    6. Jakob Söhl, 2012. "Confidence sets in nonparametric calibration of exponential Lévy models," SFB 649 Discussion Papers SFB649DP2012-012, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    7. Söhl, Jakob, 2010. "Polar sets for anisotropic Gaussian random fields," Statistics & Probability Letters, Elsevier, vol. 80(9-10), pages 840-847, May.
    8. Johanna Kappus, 2012. "Nonparametric adaptive estimation of linear functionals for low frequency observed Lévy processes," SFB 649 Discussion Papers SFB649DP2012-016, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    9. Song, Seongjoo, 2010. "Lévy density estimation via information projection onto wavelet subspaces," Statistics & Probability Letters, Elsevier, vol. 80(21-22), pages 1623-1632, November.
    10. Kappus, Johanna, 2014. "Adaptive nonparametric estimation for Lévy processes observed at low frequency," Stochastic Processes and their Applications, Elsevier, vol. 124(1), pages 730-758.
    11. Denis Belomestny & Mathias Trabs & Alexandre Tsybakov, 2017. "Sparse covariance matrix estimation in high-dimensional deconvolution," Working Papers 2017-25, Center for Research in Economics and Statistics.
    12. Reiß, Markus, 2013. "Testing the characteristics of a Lévy process," Stochastic Processes and their Applications, Elsevier, vol. 123(7), pages 2808-2828.
    13. Fusai, Gianluca & Meucci, Attilio, 2008. "Pricing discretely monitored Asian options under Levy processes," Journal of Banking & Finance, Elsevier, vol. 32(10), pages 2076-2088, October.
    14. Jakob Söhl, 2014. "Confidence sets in nonparametric calibration of exponential Lévy models," Finance and Stochastics, Springer, vol. 18(3), pages 617-649, July.
    15. Trabs, Mathias, 2015. "Quantile estimation for Lévy measures," Stochastic Processes and their Applications, Elsevier, vol. 125(9), pages 3484-3521.
    16. Jan Kallsen & Paul Kruhner, 2013. "On a Heath-Jarrow-Morton approach for stock options," Papers 1305.5621, arXiv.org, revised Aug 2013.
    17. Jakob Sohl, 2012. "Confidence sets in nonparametric calibration of exponential L\'evy models," Papers 1202.6611, arXiv.org, revised Sep 2013.
    18. Richard Nickl & Markus Reiß, 2012. "A Donsker Theorem for Lévy Measures," SFB 649 Discussion Papers SFB649DP2012-003, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    19. Mathias Trabs, 2011. "Calibration of selfdecomposable Lévy models," SFB 649 Discussion Papers SFB649DP2011-073, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    20. Jakob Sohl & Mathias Trabs, 2012. "Option calibration of exponential L\'evy models: Confidence intervals and empirical results," Papers 1202.5983, arXiv.org, revised Oct 2012.
    21. Jeonggyu Huh, 2018. "Pricing Options with Exponential Levy Neural Network," Papers 1802.06520, arXiv.org.
    22. Denis Belomestny, 2009. "Spectral estimation of the fractional order of a Lévy process," SFB 649 Discussion Papers SFB649DP2009-021, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
    23. Jan Kallsen & Paul Krühner, 2015. "On a Heath–Jarrow–Morton approach for stock options," Finance and Stochastics, Springer, vol. 19(3), pages 583-615, July.
    24. Rama Cont & Peter Tankov, 2009. "Constant Proportion Portfolio Insurance In The Presence Of Jumps In Asset Prices," Mathematical Finance, Wiley Blackwell, vol. 19(3), pages 379-401.
    25. Chen, Song X. & Delaigle, Aurore & Hall, Peter, 2010. "Nonparametric estimation for a class of Lévy processes," Journal of Econometrics, Elsevier, vol. 157(2), pages 257-271, August.

    More about this item

    Keywords

    European option; jump diffusion; minimax rates; severely ill-posed; nonlinear inverse problem; spectral cut-off;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General

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