A Minimal Share Market Model with Stochastic Volatility
The paper describes a continuous time share market model with a minimal number of factors. These factors are powers of Bessel processes. The asset prices are formed by ratios of the factors and have consequently leptokurtic return distributions. In this framework stochastic volatility with properties that are similar to those actually observed arises naturally. The model generates for the market index the well-known leverage effect due to negative correlation between the index and its volatility. It also incorporates possible default of an asset and thus models credit risk.
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