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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 eco- nomics, 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 exist- ing finite-difference methods

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  • Zhylyevskyy, Oleksandr, 2012. "Joint Characteristic Function of Stock Log-Price and Squared Volatility in the Bates Model and Its Asset Pricing Applications," ISU General Staff Papers 201201010800001031, Iowa State University, Department of Economics.
    • Handle: RePEc:isu:genstf:201201010800001031
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