Non-causal Affine Processes with Applications to Derivative Pricing

Christian Gouriéroux () and Yang Lu
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Christian Gouriéroux: CREST; University of Toronto; Toulouse School of Economics.

No 2019-02, Working Papers from Center for Research in Economics and Statistics

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 much more complicated non affine dynamics in calendar time, while still providing (quasi) closed form term structures and derivative pricing formulas. The framework is illustrated with zero-coupon bond and European call option pricing examples.

Keywords: Derivative Pricing; Term Structure; Affine Process; Noncausal Process; Speculative Bubble; Reverse Time. (search for similar items in EconPapers)
Pages: 46 pages
Date: 2019-01-01
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