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Randomness in portfolios of options and their common underlying originates from two major sources of uncertainty: the price of the underlying and the implied volatility smile. Within the subset of portfolios whose unique source of uncertainty is the volatility smile, we derive an explicit...
Persistent link: https://www.econbiz.de/10012732289
It has been indicated by Litterman and Scheinkman (1991) that the term structure of interest rates is reliably modeled by an affine three factor model attained by principal component analysis. Such a model is inconsistent with no arbitrage: it allows portfolios with zero instantaneous variance...
Persistent link: https://www.econbiz.de/10012732294
Litterman and Scheinkman (1991) show that a three factor PCA model of the term structure fits the data in a remarkable way and is useful for hedging. However, this model is not arbitrage free under the assumption that markets are frictionless. That is, there are zero cost portfolios with...
Persistent link: https://www.econbiz.de/10012720998