This article discusses convergence problems when calculating Vega (option sensitivity to volatility) that arise from discretization errors embedded in the lattice approach. Four alternative improvements to the traditional binomial method are discussed and investigated for performance. We also propose a new Modified Binomial (MB) Method to calculate Vegas. Numerical results show that although th...

This paper introduces a new class of matrix-valued affine jump diffusions that are convenient for modeling multivariate risk factors in many financial and econometric problems. We provide an analytical transform analysis for this class of models, leading to an analytical treatment of a broad class of multivariate valuation and econometric problems. Examples of potential applications include fix...

This paper investigates a principal-agent model in which an owner (principal) optimizes a contract with a manager (agent) delegated to undertake an investment project. In the model, we explore the effects of costly exploration by which the manager learns the real value of development cost. We show that high exploration cost can lead to a pooling policy not contingent on project type. Further, a...

The paper deals with the valuation and the hedging of non path-dependent European options on one or several underlying assets in a model of an international economy allowing for both, interest rate risk and exchange rate risk. Using martingale theory and in particular the change of numeraire technique we provide a unified and easily applicable approach to pricing and hedging exchange options on...

In a continuous-time economy with complete markets, we show how the heterogeneity in the individual consumers’ risk attitudes and impatience would affect the representative consumer’s counterparts. Specifically, our formulas tell us how his risk tolerance and impatience will change over time, and how his impatience will be affected by the changes in aggregate consumption levels. Under the assum...

This research compares partial equilibrium and statistical time-series approaches to hedging. The finance literature stresses the former approach, while the applied economics literature has focused on the latter. We compare the out-of-sample hedging effectiveness of the two approaches when hedging commodity price risk using futures contracts. For various methods of parameter estimation and infe...

This paper derives semi-analytical pricing formulae for geometric average options (GAO) within a stochastic volatility framework. Assuming a general mean reverting process for the underlying asset and a square-root process for the volatility, the cross-moment generating function is derived and the cumulative probabilities are recovered using the Gauss-Laguerre quadrature rule. Fixed and floatin...

Premiums on U.S. sovereign CDS have risen to persistently elevated levels since the financial crisis. We ask whether these premiums reflect the probability of a fiscal default – a state in which budget balance can no longer be restored by raising taxes or eroding the real value of debt by raising inflation. We develop an equilibrium macrofinance model in which the fiscal and monetary policy sta...

I use daily futures price data to examine the behavior of natural gas and crude oil price volatility in the U.S. since 1990. I test whether there has been a significant trend in volatility, whether there was a short-term increase in volatility during the time of the Enron collapse, and whether natural gas and crude oil price volatilities are interrelated. I also measure the persistence of shock...

This paper presents a dynamic model of takeovers based on the stock market valuations of merging firms. The model incorporates competition and imperfect information and determines the terms and timing of takeovers by solving option exercise games between bidding and target shareholders. The implications of the model for returns to stockholders are consistent with the available evidence. In addi...