LINEAR-QUADRATIC JUMP-DIFFUSION MODELING |
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Authors: | Peng Cheng Olivier Scaillet |
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Institution: | Barclays Capital and Swiss Finance Institute; HEC, Universitéde Genève and Swiss Finance Institute |
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Abstract: | We aim at accommodating the existing affine jump-diffusion and quadratic models under the same roof, namely the linear-quadratic jump-diffusion (LQJD) class. We give a complete characterization of the dynamics of this class by stating explicitly the structural constraints, as well as the admissibility conditions. This allows us to carry out a specification analysis for the three-factor LQJD models. We compute the standard transform of the state vector relevant to asset pricing up to a system of ordinary differential equations. We show that the LQJD class can be embedded into the affine class using an augmented state vector. This establishes a one-to-one equivalence relationship between both classes in terms of transform analysis. |
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Keywords: | linear-quadratic models affine models jump-diffusions standard transform option pricing |
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