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A minimal financial market model

Eckhard Platen ()

No 2000,91, SFB 373 Discussion Papers from Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes

Abstract: The paper proposes a financial market model that generates stochastic volatility and stochastic interest rate using a minimal number of factors that characterise the dynamics of the different denominations of the deflator. It models asset prices essentially as functionals of square root and Ornstein-Uhlenbeek processes. The resulting price processes exhibit stochastic volatility with leptokurtic log-return distributions that c1osely match those observed in reality. The resulting index of the market is negatively correlated with its volatility which models the well-known leverage effect. The average growth rates of the different denominations of the deflator are Ornstein-Uhlenbeek processes which generates the typically observed long term Gaussianity of logreturns of asset prices.

Keywords: stochastic volatility; financial market model; derivative pricing; square root process (search for similar items in EconPapers)
JEL-codes: G10 G13 (search for similar items in EconPapers)
Date: 2000
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Related works:
Working Paper: A Minimal Financial Market Model (2001)
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