Joint Characteristic Function of Stock Log-Price and Squared Volatility in the Bates Model and Its Asset Pricing Applications
Oleksandr Zhylyevskyy ()
Staff General Research Papers Archive from Iowa State University, Department of Economics
The model of Bates specifies a rich, flexible structure of stock dynamics suitable for applications in finance and economics, including valuation of derivative securities. This paper analytically derives a closed-form expression for the joint conditional characteristic function of a stock's log-price and squared volatility under the model dynamics. The use of the function, based on inverting it, is illustrated on examples of pricing European-, Bermudan-, and American-style options. The discussed approach for European-style derivatives improves on the option formula of Bates. The suggested approach for American-style derivatives, based on a compound-option technique, offers an alternative solution to existing finite-difference methods.
Keywords: stochastic volatility; Bates model; jump-diffusion; characteristic function; option pricing (search for similar items in EconPapers)
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Published in Theoretical Economics Letters, October 2012, vol. 2 no. 4, pp. 400-407
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Persistent link: https://EconPapers.repec.org/RePEc:isu:genres:35559
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