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Option pricing and hedging under a stochastic volatility Lévy process model |
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| Authors: | Young Shin Kim Frank J Fabozzi Zuodong Lin Svetlozar T Rachev |
| Institution: | 1. Department of Statistics, Econometrics and Mathematical Finance, School of Economics and Business Engineering, Karlsruhe Institute of Technology, Karlsruhe, Germany 2. EDHEC Business School, New York, NY, USA 3. HECTOR School of Engineering and Management, International Department, Karlsruhe Institute of Technology, Karlsruhe, Germany 4. Department of Applied Mathematics and Statistics, Stony Brook University, Stony Brook, NY, USA 5. FinAnalytica, Seattle, WA, Germany |
| Abstract: | In this paper, we discuss a stochastic volatility model with a Lévy driving process and then apply the model to option pricing and hedging. The stochastic volatility in our model is defined by the continuous Markov chain. The risk-neutral measure is obtained by applying the Esscher transform. The option price using this model is computed by the Fourier transform method. We obtain the closed-form solution for the hedge ratio by applying locally risk-minimizing hedging. |
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