Pricing of mountain range derivatives under a principal component stochastic volatility model
Article first published online: 27 MAR 2012
Copyright © 2012 John Wiley & Sons, Ltd.
Applied Stochastic Models in Business and Industry
Volume 29, Issue 1, pages 31–44, January/February 2013
How to Cite
Escobar, M. and Olivares, P. (2013), Pricing of mountain range derivatives under a principal component stochastic volatility model. Appl. Stochastic Models Bus. Ind., 29: 31–44. doi: 10.1002/asmb.936
- Issue published online: 12 FEB 2013
- Article first published online: 27 MAR 2012
- Manuscript Accepted: 22 SEP 2011
- Manuscript Revised: 16 SEP 2011
- Manuscript Received: 15 DEC 2010
- stochastic covariance matrix;
- principal component analysis;
- mountain range derivatives
In this paper, a multidimensional stochastic volatility process is introduced. This process is simpler than existing ones in terms of number of parameters while keeping practical stylized facts like stochastic correlation and volatility. The pricing of two mountain range derivatives, Altavista and Everest, is analyzed under this framework, showing sensitivities to parameters, number of eigenvalues, and maturity time. Copyright © 2012 John Wiley & Sons, Ltd.