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Generalized Mean-Reverting 4/2 Factor Model

Department of Statistical and Actuarial Sciences, Western University, London, ON N6A 3K7, Canada
Author to whom correspondence should be addressed.
These authors contributed equally to this work.
J. Risk Financial Manag. 2019, 12(4), 159;
Received: 13 September 2019 / Revised: 23 September 2019 / Accepted: 26 September 2019 / Published: 8 October 2019
(This article belongs to the Special Issue Computational Finance)
This paper proposes and investigates a multivariate 4/2 Factor Model. The name 4/2 comes from the superposition of a CIR term and a 3/2-model component. Our model goes multidimensional along the lines of a principal component and factor covariance decomposition. We find conditions for well-defined changes of measure and we also find two key characteristic functions in closed-form, which help with pricing and risk measure calculations. In a numerical example, we demonstrate the significant impact of the newly added 3/2 component (parameter b) and the common factor (a), both with respect to changes on the implied volatility surface (up to 100%) and on two risk measures: value at risk and expected shortfall where an increase of up to 29% was detected. View Full-Text
Keywords: stochastic covariance; 4/2 model; option pricing; risk measures stochastic covariance; 4/2 model; option pricing; risk measures
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MDPI and ACS Style

Cheng, Y.; Escobar-Anel, M.; Gong, Z. Generalized Mean-Reverting 4/2 Factor Model. J. Risk Financial Manag. 2019, 12, 159.

AMA Style

Cheng Y, Escobar-Anel M, Gong Z. Generalized Mean-Reverting 4/2 Factor Model. Journal of Risk and Financial Management. 2019; 12(4):159.

Chicago/Turabian Style

Cheng, Yuyang, Marcos Escobar-Anel, and Zhenxian Gong. 2019. "Generalized Mean-Reverting 4/2 Factor Model" Journal of Risk and Financial Management 12, no. 4: 159.

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