Real World Pricing for a Modified Constant Elasticity of Variance Model

Shane M Miller and Eckhard Platen ()
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Shane M Miller: Citigroup Australia

No 237, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: This paper considers a modified constant elasticity of variance (MCEV) model. This model uses the familiar constant elasticity of variance form for the volatility of the growth optimal portfolio (GOP) in a continuous market. It leads to a GOP that follows the power of a time-transformed squared Bessel process. This paper derives analytic real-world prices for zero-coupon bonds, instantaneous forward rates and options on the GOP that are both theoretically revealing and computationally efficient. In addition, the paper examines options on exchange prices and options on zero-coupon bonds under the MCEV model. The semi-analytic prices derived for options on zero-coupon bonds can subsequently be used to price interest rate caps and floors.

Keywords: benchmark approach; real-world pricing; growth optimal portfolio; constant elasticity of variance; zero-coupon bonds; exchange prices; interest rate caps and floors (search for similar items in EconPapers)
JEL-codes: G10 G13 (search for similar items in EconPapers)
Date: 2008-11-01

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Persistent link: http://EconPapers.repec.org/RePEc:uts:rpaper:237

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