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12

You can directly imply a probability distribution from a volatility skew. Note that, for any terminal probability distribution $p(S)$ at tenor $T$, we have the model-free formula for the call price $C(K)$ as a function of strike $K$ \begin{equation} C=e^{-rT} \int_0^\infty (S-K)^+ p(S) dS \end{equation} Therefore we can write \begin{equation} e^{rT} ...


10

There are a number of different tests that are generally used to compare samples to different distributions, such as Jarque-Bera, Anderson-Darling, and Kolmogorov–Smirnov (see this related question). In your case, with just the standard deviation and mean, there isn't a whole lot to say. You need to assume a distribution (e.g. normal). You would be able ...


10

Interest rates in general are far from independent and identically distributed. A high interest rate observation is quite likely to be followed by another high observation, and the volatility is likely to be higher as well. Interest rates are also mean reverting, as in most real-world situations (at least for developed markets) interest rates rarely rise ...


6

What you refer to as the 99.5th percentile is known as the "Value-at-Risk." You are correct that you will need to make a distributional assumption, and there is a popular and well-researched approach to this problem, though I'm not certain it could be called "standard." I would recommend you use the "truncated Levy flight" distribution. James Xiong at ...


5

Be careful, remember that the mean and the standard deviation don't tell you the whole story: http://en.wikipedia.org/wiki/Anscombe%27s_quartet


5

I think an extremely interesting strand of research on this topic is represented by extensions of vine copulas with time-varying parameters. For vine copulas in general have a look at this site from the Technische Universität München: Vine Copula Models One of their research projects, which is the most relevant in this context, is:Time varying vine copula ...


4

These returns are almost always modeled by finding some fundamental two-sided variable and modeling that. For options, we would model their prices as derivatives -- we would take the log-returns of underlying prices as the fundamental variable, possibly with other models for what would happen to volatilities and the like, and compute the consequences for ...


4

That can be a somewhat difficult question to answer, given that the context may yield different distributions. Nevertheless, I think that you could try to fit the best distribution algorithmically. For instance, lately I found this package at Matlab file exchange: Finding the best distribution that fits the data Link (...) This is where Mike's ...


3

Maybe this could also be a comment but I think an it is not possible to answer this question with a 'yes and here is how you do it'. It has been tried, e.g. by me for a university research project. In this research we focused primarily on aggregation of returns and the main problem was the tractability of the resulting distributions and expressions, also ...


3

It's not possible with a simple linear transformation like the one you mentioned: since scale and thus the distance between mean and median are required to change, either the mean or the median will not be preserved. Therefore you must use nonlinear transformations, which will complicate quite a bit mantaining skew and kurtosis and imho will not be ...


3

the risk neutral drift is needed for pricing of derivatives. For a $100\%$ equity portfolio you can take the real world drift - sometimes a good guess is a drift of zero. For fixed-income you could do the same and might need more sophistication for the variance term. If you have short-dated bonds then you will need a special model for the pull-to-par. For ...


3

You could try using the Gaussian Affine Term Structure Models (GATSM), with the right boundary conditions to stop rates being negative (in the style of their Black implementation). See, for example, Monika Piazzesi, the "Affine Term Structure Models" if you want to enter/modify the basis or the work of Krippner, for example "Measuring the stance of monetary ...


3

Exponential distribution, although it's a good distribution for modeling non-negative numbers, doesn't make sense here since it's mode is 0. From a pure statistical point of view, without any knowledge of interest rate, I'd recommend log-normal as in modeling stock prices and inverse-gamma or gamma distribution which are used to model variance or other ...


3

The pdfs of Student-t distributions have asymptotically Paretian tails, and the tail shape parameter (aka the maximal moment exponent) is equal to the distribution's degrees of freedom parameter. Assuming you have enough observations, you could estimate the Pareto parameter using the so-called Hill method (named after Bruce Hill, 1975). A word of caution: ...


3

I found Coping With Copulas by Thorsten Schmidt really helped me to get a more basic understanding of copulas. As well as looking at some simple examples in R and thinking about different directions the transformations can happen. To answer your actual question I'll attempt to describe the steps involved as simply as I can. Let's say you use the copula ...


3

Hi bcf: This is a good question. As you pointed out below, \begin{align*} p_0 &= \delta(y-y_0)\\ &=\delta(e^w-y_0). \end{align*} Then, \begin{align*} p_0 * g &= \int_{-\infty}^{\infty}\delta(e^z-y_0) g(w-z) dz\\ &=\int_{0}^{\infty}\delta(u-y_0) g(w-\ln u) \frac{1}{u}du\\ &= \frac{1}{y_0}g(w-\ln y_0). \end{align*} Consequently, your last ...


3

Surely, there is; search for aggregational gaussianity in Google Scholar or ScienceDirect. In fact, 5 minutes returns are leptokurtic and fat-tailed; then as you increase timeframe, returns become more and more normal. Yearly data is almost normal, if you have enough points.


3

My main reference will be "Dan Xu, Christian Beck - Transition from lognormal to chi-square superstatistics for financial time series" Non-equilibrium statistical mechanics (more specifically, superstatistics) gives some ideas of explaining the relation between time frame and its distribution: "...to regard the time series as a superposition of local ...


3

Your question is not clear. What you might want to say is what distribution should the futures price follow, under the risk-neutral or physical probability measure. In this sense, it will depend on your intention. For potential future exposure, you may want to use the physical measure for the price evolution, while the distribution will depend on your model ...


2

Once we start building time-varying copulas like Lopes suggests in that paper, I think we are better off venturing into the world of state space models. When viewed in a bayesian context, the similarities between the approaches are striking to me. The advantage of the copula, as I understand it, is that it is a quick and dirty way to understand the ...


2

Your question is interesting because I thought that the only chance with Lévy-processes is to use Fourier-transform approaches (see e.g. Cont,Tankov). But in the paper Option Pricing for Log-Symmetric Distributions of Returns by Fima C. Klebaner· Zinoviy Landsman they consider models, where the log of the price has a symmetric distribution. In Corollary 3.2 ...


2

By accident i stumbled upon a new work submitted yesterday (http://arxiv.org/abs/1208.5896). It seems most papers are talking about a specific dataset following Benfords law. But that seems not to be what you are looking for. You should look into this bibliography here ( about Benford's law in general): http://arxiv.org/abs/math/0607168 There are also ...


2

It could be much more simple: if you use the method of moments (MM) then you estimate the mean and the variance and for example the kurtosis of your sample. Then you fit the parameters to these statistics. Alternatively you use maximum-likelihood (MLE). For MM: from wikipedia you get the mean and the variance. In your notation you can fit $b = \bar{r}$ so ...


2

The consensus nowadays is that stable distributions are not a well fit, although they do possess heavy tails. In particular Cauchy has too fat tails. The reasons for this are disparate, however the first that comes to mind is that empirically longer horizons show a decrease in tail thickness, approaching normality for 1-year returns (although this has been ...


2

I think modelling hedge fund returns is a very interesting yet demanding task. Your model will have to strike a balance between the tangibility of the model on the one hand and the possibility of parameter estimation on the other. Plus I think you will encounter hedge funds that resist all modelling attempts because there strategies are just too elusive. ...


2

Historical returns are not to be used 'untreated' for the calculation of option prices. The expectation that you will be using in Monte Carlo will take the form $$ C(K,T) = E^Q\{D(T)\ \max[0, S_T-K, 0]\} $$ where $T$ is the maturity, $K$ is the strike price, $S$ is the stock price and $D$ is the discount factor. But the expectation is taken under the 'risk ...


2

You can express the Normal distribution by Sklar's Theorem in terms of Gaussian Marginals and Gaussian Copula as follows: $$F(x_1,...,x_n)=C(F(x_1),...,F(x_n))=C^{Gau}(N(x_1),...,N(x_n))$$ So the distribution equals the copula function with the respective inverse marginals as arguments. You can aswell combine any types of Copula and (continuous) different ...


2

There are many ways answering this, here is one: We assume the asset price at $t=T$, $S_T = S_{T-1} \times (S_T / S_{T-1})$. Assuming continuous compounding, we can write, $S_T = S_{T-1} \times \exp(R_{T-1})$. Working the same way for the previous period, we get $S_{T} = S_{T-2} \times \exp(R_{T-1}+R_T)$. Working all the way back to the initial value of ...


2

The best introduction to copulas I know, i.e. with rigour and intuition, is the following. THE QUANT CLASSROOM BY ATTILIO MEUCCI A Short, Comprehensive, Practical Guide to Copulas Visually introducing a powerful risk management tool to generalize and stress-test correlations


2

In the theory of copulas you want to model a multivariate (often bivariate) distribution and keep the marginals fixed. Thus you have random variables $X$ and $Y$ with cdf $F_X(x) = P[X \le x]$ and $F_Y(y) = P[Y\le y]$ and you want to find some $F_{X,Y}(x,y) = P[X \le x, Y\le y]$ such that when you look at marginals you get $F_{X,Y}(x,\infty) = F_X(x)$ and ...



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