How Much is the Gap?:Efficient Overnight Jump Risk-Adjusted Valuation of Leveraged Certificates

Zhang, Quan and Thul, Matthias (2017) How Much is the Gap?:Efficient Overnight Jump Risk-Adjusted Valuation of Leveraged Certificates. Quantitative Finance, 17 (9). pp. 1387-1401. ISSN 1469-7688

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Abstract

This paper develops a novel and highly efficient numerical algorithm for the gap risk-adjusted valuation of leveraged certificates. The existing literature relies on Monte Carlo simulations, which are not fast enough to be used in a market making environment. This is because issuers need to compute thousands of price updates per second. By valuing leveraged certificates as multi-window barrier options, we explicitly model random jumps that occur at known times, such as between the exchange closing and re-opening. Our algorithm combines the one-day transition probability with Simpson’s numerical integration rule. This yields a backward induction scheme which requires a significantly coarser spatial and time grid than finite difference methods. We confirm its robustness and accuracy through Monte Carlo simulations.

Item Type:
Journal Article
Journal or Publication Title:
Quantitative Finance
Additional Information:
This is an Accepted Manuscript of an article published by Taylor & Francis in Quantitative Finance on 7/3/2017, available online: https://www.tandfonline.com/doi/full/10.1080/14697688.2016.1276299
Uncontrolled Keywords:
/dk/atira/pure/subjectarea/asjc/2000
Subjects:
ID Code:
128968
Deposited By:
Deposited On:
14 Nov 2018 14:14
Refereed?:
Yes
Published?:
Published
Last Modified:
18 Sep 2020 04:35