Sato Processes and the Valuation of Structured Products
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Date: 11-30-2006
Start Time:
1:30pm
End Time: 2:30pm
Speaker: Dilip Madan, University of Maryland
Location: Mudd 303
Abstract
We report on the adequacy of using Sato processes to value equity structured products. An analysis of the variance of realized variance for Sato processes shows that these processes may be suited to option contracts on realized volatility. Nonlinear pricing principles based on hedging to acceptability are outlined for the purpose of pricing structured transactions. It is shown that typically different products should be priced using different models. Pricing comparisons of Sato process prices with other standard models like Heston stochastic volatility, with and without jumps, VGSA, local volatility, and local CGMY are also provided. Sato processes tend to overprice cliquets relative to other models. They also maintain the value of long dated out-of-the-money realized variance options.
Bio
Dilip Madan is professor of finance at the Robert H. Smith School of Business specializing in Mathematical Finance. He currently serves as a consultant to Morgan Stanley, Caspian Capital LLC, and Bloomberg and has previously served as consultant to Wachovia Securities and the FDIC. He is a recipient of the 2006 Humboldt award in mathematics, founding member and past president of the Bachelier Finance Society, managing editor of Mathematical Finance and associate editor for the Journal of Credit Risk and Quantitative Finance. His work is dedicated to improving the quality of financial valuation models, enhancing the performance of investment strategies, and advancing the understanding and operation of efficient risk allocation in modern economies. Recent major contributions have appeared in Mathematical Finance, Finance and Stochastics, Quantitative Finance, the Journal of Computational Finance, among other journals.