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A Minimal Financial Market Model

The paper proposes a financial market model that generates stochastic volatilities and stochastic interest rates using a minimal number of factors that characterise the dynamics of different denominations of a benchmark portfolio. It models asset prices essentially as functionals of square root and Ornstein-Uhlenbeck processes. The resulting price processes exhibit stochastic volatility with leptokurtic log-return distributions that closely match those observed in reality. The benchmark portfolio is negatively correlated with its volatility which models the well-known leverage effect. The average growth rates of the different denominations of the benchmark portfolio are Ornstein-Uhlenbeck processes which generates the typically observed long term Gaussianity of log-returns of asset prices.

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Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 48.

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Date of creation: 01 Mar 2001
Date of revision:
Publication status: Published as: Platen, E., 2001, "A Minimal Financial Market Model", Trends in Mathematics, 293-301.
Handle: RePEc:uts:rpaper:48
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