Common Decomposition of Correlated Brownian Motions and its Financial Applications
Xue Cheng and
Papers from arXiv.org
In this paper, we develop a theory of common decomposition for two correlated Brownian motions, in which, by using change of time method, the correlated Brownian motions are represented by a triple of processes, $(X,Y,T)$, where $X$ and $Y$ are independent Brownian motions. We show the equivalent conditions for the triple being independent. We discuss the connection and difference of the common decomposition with the local correlation model. Indicated by the discussion, we propose a new method for constructing correlated Brownian motions which performs very well in simulation. For applications, we use these very general results for pricing of two-factor financial derivatives whose payoffs rely very much on the correlations of underlyings. And in addition, with the help of numerical method, we also make a discussion of the pricing deviation when substituting a constant correlation model for a general one.
New Economics Papers: this item is included in nep-cmp
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed
Downloads: (external link)
http://arxiv.org/pdf/1907.03295 Latest version (application/pdf)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1907.03295
Access Statistics for this paper
More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().