A Comparative Analysis of Basket Default Swaps Pricing Using the Stein Method
- - Dorinel Bastide, Eric Benhamou and Marian
Using the Stein numerical method, introduced by El Karoui and Jiao and El Karoui et al., the paper compares, in terms of accuracy and efficiency, the pricing of the basket default swaps (NTDs and CDO tranches). In the factor copula model framework, the paper compares the following copula functions: one-factor and three-factors Gaussian copula, Clayton copula, Marshall-Olkin copula, Double-t copula and Student copula. Stein numerical method is also compared with the Recursive method of Hull and White, probability generating function method (an exact Fourier transform like method) and the Monte Carlo method.
© 2008 IUP . All Rights Reserved.
Implied Volatility by Variance Decomposition Method
- - Joocheol Kim, WooWhan Kim and KiHyung Kim
This paper provides the variance decomposition method to calculate the market volatility index implied in option price and compares the prediction quality of realized volatility with VIX, which is a well-known volatility index. The method is based on the variance calculation conditioned on strike price. Using the high-frequency data, the authors calculate variance decomposition volatility as well as VIX and compare the prediction quality of these indexes for realized volatility. The empirical result shows that variance decomposition volatility index has similar dynamics of VIX and shows good prediction power of realized volatility.
© 2008 IUP . All Rights Reserved.
The Relationship Between Hedging Through Forwards, Futures and Swaps and Corporate Capital Structure in Malaysia
- - M Fazillah, Noor Azlinna Azizan and Tay Siang Hui
This paper focuses on the simultaneity relationship between hedging through forwards, futures, swaps and capital structure for non-financial Malaysian firms. The determinants of hedging and capital structure are ascertained and a two-stage regression analysis using pooled data of firms listed on Malaysian Stock Exchange, Bursa Malaysia, from 2001-2005 is performed. The analysis shows that simultaneity relationship exists between hedging and capital structure. Hedging reduces financial distress cost and increases firm's debt capacity. Since there are tax incentives in debt financing, firms will be induced to borrow more to take advantage of the potential tax benefits. However, increase in debt will further increase the likelihood of financial distress, thus firms will hedge more to mitigate the increased risks.
© 2008 IUP . All Rights Reserved.
Option Pricing Using Adaptive Neuro-Fuzzy System (ANFIS)
- - M Kakati
This paper applies an Adaptive Neuro-Fuzzy Inference System (ANFIS) for improving the estimation of option market prices. The research designs seven ANFIS models, one for each underlying stock, based on the transaction data of the Indian Stock Option with three volatility measures, namely historical volatility, implied volatility, and GARCH volatility. The pricing capability of each model has been compared with the performance of the pure Artificial Neural Net (ANN) and Black-Scholes (BS) model. Empirical results show that out-of-sample pricing performance of ANFIS is superior to BS, and is also better than pure ANN. The results confirm that the ANFIS model could significantly reduce the Root Mean Square Errors (RMSE) of forecasting, and also provide an alternative way to refine the options' valuation. Further, ANFIS is an interesting alternative for neural modeling which has the same capabilities as standard back-propagation network but is explicit about its decision rules.
© 2008 IUP . All Rights Reserved.
Empirical Study of the Effect of Including Skewness and Kurtosis in Black-Scholes Option Pricing Formula on S&P CNX Nifty Index Options
- - Manvendra Tiwari and Rritu Saurabha
The most popular model for pricing options, both in financial literature as well as in practice has been the Black-Scholes model. In spite of its widespread use, the model appears to be deficient in pricing deep-in-the-money and deep-out-of-the-money options using statistical estimates of volatility. This limitation has been taken into account by practitioners using the concept of implied volatility. Many improvements to the Black-Scholes formula have been suggested in academic literature for addressing the issue of volatility smile. This paper studies the effect of using a variation of the Black-Scholes model (suggested by Corrado and Sue incorporating non-normal skewness and kurtosis) to price call options on S&P CNX Nifty. The results strongly suggest that the incorporation of skewness and kurtosis into the option pricing formula yields values much closer to market prices. Based on this result and the fact that this approach does not add any further complexities to the option pricing formula, it is suggested that this modified approach should be considered as a better alternative.
© 2008 IUP . All Rights Reserved.
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