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Home > Business & Economics > Business General & Other > Volatility and Correlation: The Perfect Hedger and the Fox-eBook

Volatility and Correlation: The Perfect Hedger and the Fox

Rebonato, Riccardo

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Volatility and Correlation: The Perfect Hedger and the Fox

In Volatility and Correlation 2nd edition: The Perfect Hedger and the Fox, Rebonato looks at derivatives pricing from the angle of volatility and correlation. With both practical and theoretical applications, this is a thorough update of the highly successful Volatility & Correlation with over 80% new or fully reworked material and is a must have both for practitioners and for students. The new and updated material includes a critical examination of the perfect-replication approach to derivatives pricing, with special attention given to exotic options; a thorough analysis of the role of quadratic variation in derivatives pricing and hedging; a discussion of the informational efficiency of markets in commonly-used calibration and hedging practices. Treatment of new models including Variance Gamma, displaced diffusion, stochastic volatility for interest-rate smiles and equity/FX options. The book is split into four parts. Part I deals with a Black world without smiles, sets out the author's philosophical approach and covers deterministic volatility. Part II looks at smiles in equity and FX worlds. It begins with a review of relevant empirical information about smiles, and provides coverage of local-stochastic-volatility, general-stochastic-volatility, jump-diffusion and Variance-Gamma processes. Part II concludes with an important chapter that discusses if and to what extent one can dispense with an explicit specification of a model, and can directly prescribe the dynamics of the smile surface. Part III focusses on interest rates when the volatility is deterministic. Part IV extends this setting in order to account for smiles in a financially motivated and computationally tractable manner. In this final part the author deals with CEV processes, with diffusive stochastic volatility and with Markov-chain processes.

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Title of ebook: Volatility and Correlation: The Perfect Hedger and the Fox
ISBN: 9780470091401
Publisher: John Wiley & Sons, Inc.
Internet download file size: 8958 kb
Pages: 864
Released online for download: 07-08-2005
Author of eBook: Rebonato, Riccardo

Volatility and Correlation

The Perfect Hedger and the Fox

Chapter One

Theory and Practice of Option Modelling

1.1 The Role of Models in Derivatives Pricing

1.1.1 What Are Models For?

The idea that the price of a financial instrument might be arrived at using a complex mathematical formula is relatively new, and can be traced back to the Black-and-Scholes (1973) formula. Of course, formulae were used before then for pricing purposes, for instance in order to convert the price of a bond into its gross redemption yield. However, these early (pre Black-and-Scholes) formulae by and large provided a very transparent transformation from one set of variables to another, and did not carry along a heavy baggage of model assumptions. The Black-and-Scholes formula changed all that, and we now live in a world where it is accepted that the value of certain illiquid derivative securities can be arrived at on the basis of a model (the acceptance of this is the basis of the practice of marking-to-model).

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