Noncausal affine processes with applications to derivative pricing

Christian Gouriéroux and Yang Lu

Mathematical Finance, 2023, vol. 33, issue 3, 766-796

Abstract: Linear factor models, where the factors are affine processes, play a key role in Finance, since they allow for quasi‐closed form expressions of the term structure of risks. We introduce the class of noncausal affine linear factor models by considering factors that are affine in reverse time. These models are especially relevant for pricing sequences of speculative bubbles. We show that they feature nonaffine dynamics in calendar time, while still providing (quasi) closed form term structures and derivative pricing formulas. The framework is illustrated with term structure of interest rates and European call option pricing examples.

Date: 2023
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