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    Sugga Estions

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    The document provides suggestions for several potential final project topics in continuous-time finance. Some topics discussed include: - Analyzing the theoretical justification for pricing American options using dynamic programming principles. - Numerically solving the partial differential equation for American option prices using finite difference methods like Crank-Nicolson or successive over-relaxation. - Pricing other path-dependent options like Asian options. - Developing numerical methods for solving problems in two-dimensional state spaces. - Modeling stochastic volatility, jumps, or local volatility in option pricing models. - Constructing static hedging portfolios and comparing to dynamic hedging. - Implementing and analyzing short-rate models like

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    Sugga Estions

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    seanwu95
    45 views4 pages
    The document provides suggestions for several potential final project topics in continuous-time finance. Some topics discussed include: - Analyzing the theoretical justification for pricing American options using dynamic programming principles. - Numerically solving the partial differential equation for American option prices using finite difference methods like Crank-Nicolson or successive over-relaxation. - Pricing other path-dependent options like Asian options. - Developing numerical methods for solving problems in two-dimensional state spaces. - Modeling stochastic volatility, jumps, or local volatility in option pricing models. - Constructing static hedging portfolios and comparing to dynamic hedging. - Implementing and analyzing short-rate models like

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    The document provides suggestions for several potential final project topics in continuous-time finance. Some topics discussed include: - Analyzing the theoretical justification for pricing American options using dynamic programming principles. - Numerically solving the partial differential equation for American option prices using finite difference methods like Crank-Nicolson or successive over-relaxation. - Pricing other path-dependent options like Asian options. - Developing numerical methods for solving problems in two-dimensional state spaces. - Modeling stochastic volatility, jumps, or local volatility in option pricing models. - Constructing static hedging portfolios and comparing to dynamic hedging. - Implementing and analyzing short-rate models like

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
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    45 views4 pages

    Sugga Estions

    Uploaded by

    seanwu95
    The document provides suggestions for several potential final project topics in continuous-time finance. Some topics discussed include: - Analyzing the theoretical justification for pricing American options using dynamic programming principles. - Numerically solving the partial differential equation for American option prices using finite difference methods like Crank-Nicolson or successive over-relaxation. - Pricing other path-dependent options like Asian options. - Developing numerical methods for solving problems in two-dimensional state spaces. - Modeling stochastic volatility, jumps, or local volatility in option pricing models. - Constructing static hedging portfolios and comparing to dynamic hedging. - Implementing and analyzing short-rate models like

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    You are on page 1of 4

    May 1, 2003

    Rolf Poulsen
    AMS, IMF, KU
    [email protected]

    Topics in Continuous-Time Finance


    Suggestions for Final Projects
    blah blah blah

    American Options
    Theoretical angle: Is American option pricing rigorously justified? Specifically, why is it that
    A (t) =

    sup

    r( t)
    EQ
    Pay-off( )) ?
    t (e

    stopping time

    Can this be supported by an any other price would give arbitrage-statement?


    It can. In continuous time its tricky, but a discrete word (a binomial model
    for instance) its doable. Work your way trough Section 4.3 in Pliska (1997)
    (the book can be found in the Actuarial library).
    PDE angle: Solve the PDE for the price numerically. Does naive CrankNicolson loose an order, meaning that its no faster then the binomial method?
    What happens when an iterative technique like successive over-relaxation is
    used on the linear complementary formulation? Work/implement your way
    through Section 4.5 in Seydel (2002).
    (Something that has not been mentioned at the lectures) Simulation angle:
    Seemingly, it is not feasible to price American options by simulation. But
    things are not what they seem. Work trough to first sections of Longstaff &
    Schwartz (2001). Implement their method for the base-case American put.
    Compare to the binomial model. The ambitious student(s, most likely) will
    look at the proofs.

    PDEs & Not Plain Vanilla Options

    Asian Options
    Section in 6.2 Seydel (2002). Jump conditions. Could take a look at Alziary,
    Dechamps & Koehl (1997).
    2-D Space
    Whatever do you do with a 2-D space variable (2 stocks)? Explicit method:
    Doable (with more things to keep track of) but usual order and especially
    stability problems. Implicit methods: Nasty coefficient matrices. Solution:
    Alternating direction implicit method.
    Accessible introduction with finance use: Wilmott (1998)[Chapter 48] Testcase: Margrabes exchange option. Interesting case: Pay-off (S1 S2 K)+ .
    Numerical literature introduction: Strikwerda (1989)[Section 7.3] or Mitchell
    & Griffiths (1980)[Section 2.12]. These are more demanding, but you get to
    work on easier test problems. (For instance solving Exercise 7.3.2 in Strikwerda more than suffices for a project.)
    A Passport Option
    Too tricky . . .?

    Plain Vanilla Options, But Not the Black/Scholes World


    Stochastic Volatility Models
    Read Hestons article. If you are good at complex analysis: Give the details
    of the inversion. If (like me) youre not: Implement the formula. Verify the
    implemantation through simulation. Possible the smart/mixing simulation
    approach from Romano & Touzi/Lewis.
    Plot model smiles. Find some option data and compare.
    Jump-Diffusion
    Hmmm, I dont know. Work your way through Mertons original article?
    Local Volatility Models
    Get to appreciate Dupires forward equation; demonstrate that it works in
    the Black/Scholes-case. Implement for other volatility functions. Dig up option data. Try to back out the volatility function. This reqires considerable
    regularization.

    Static Hedging
    Construct the replicating portfolios by puts and calls. Compare (through
    simulation) static hedging to dynamic hedging (as in Project 1). Look at how
    Derman, Ergener & Kani (1995) do it.

    Interest Rates
    The CIR model
    See the questions elsewhere on the course homepage. There are (evidently) far
    too many questions for one project. Feel free to pick and choose.
    Classic short rate models
    Implementation-free angle: Read the original article Vasicek (1977) and
    answer the questions posted elsewhere on the course homepage.
    Empirical angle: Get hold of time series data on observed ZC yield curves.
    (There are some Danish curves on the homepage.) Pick out some yield
    time series; estimate an Ornstein/Uhlenbeck/Vasicek model on it. Statistics/econometric questions: What are parameter estimates; what are their
    standard deviations; how stable are the estimates; how well-specified is the
    model?
    Finance questions: How well are yield curves explained by the model; possible after risk-premia estimation & inclusion? How well are yield volatilities
    explained? Bjork (1998)[Chapter 17] explains how to calibrate the Vasicek
    model in theory. Implement that. How do these calibrated models behave
    out of sample? Recipe: Rogers & Stummer (2000); read & repeat (on DK
    data for instance).
    Embedded Interest Rate Options
    Option 1: Bermudan option approach to callable mortgage-backed bonds.
    Jrgensen, Miltersen & Srensen (1999): Read and repeat. Requires the numerical solution of PDE, but real data are not particularly needed.
    Option 2: Work through the pricing algorithm for options on coupon bonds in
    one-factor/Vasicek models. Implement it. Test it via i) simulation ii) solutions
    for ZCB options. Compare observed prices of embedded Bermudan options
    (in realkreditobligationer) to theoretical prices of European options.
    Option 3 Find some model where you can price cap-contracts. Work through
    the last part of the Mathematical Finance 2001-exam. Get some data &
    3

    determine the spreads. Take a look at my Capped ARMs-paper (on the


    homepage).
    LIBOR market models What are they all about?
    A Gaussian Two-factor Model Work your way through the first pages of Section 4.2 in Brigo & Mercurio (2001).

    References
    Alziary, B., Dechamps, J.-P. & Koehl, P.-F. (1997), A p.d.e. approach to
    Asian options: Analytical and numerical evidence, Journal of Banking
    and Finance 21, 613640.
    Bjork, T. (1998), Arbitrage Theory in Continuous Time, Oxford.
    Brigo, D. & Mercurio, F. (2001), Interest Rate Models Theory and Practice,
    Springer.
    Derman, E., Ergener, D. & Kani, I. (1995), Static Options Replication, Journal of Derivatives 2, 7895.
    Jrgensen, P. L., Miltersen, K. R. & Srensen, C. (1999), A Comparison of
    Call Strategies for Callable Annuity Mortgages. Working paper, Odense
    University.
    Longstaff, F. A. & Schwartz, E. (2001), Valuing american options by simulation: A simple least-squares approach, Review of Financial Studies
    14, 113147.
    Mitchell, A. R. & Griffiths, D. F. (1980), The Finite Difference Method in
    Partial Differential Equations, Wiley.
    Pliska, S. (1997), Introduction to Mathematical Finance, 1. edn, Blackwell.
    Rogers, L. C. G. & Stummer, W. (2000), Consistent fitting of one-factor models to interest rate data, Insurance: Mathematics & Economics 27, 4563.
    Seydel, R. (2002), Tools for Computational Finance, Springer.
    Strikwerda, J. (1989), Finite Difference Schemes and Partial Differential
    Equations, Wadsworth & Brooks/Cole.
    Vasicek, O. (1977), An Equilibrium Characterization of the Term Structure,
    Journal of Financial Economics 5, 177188.
    Wilmott, P. (1998), Derivatives, Wiley.

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