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Open AccessArticle

Generalized Mean-Reverting 4/2 Factor Model

Department of Statistical and Actuarial Sciences, Western University, London, ON N6A 3K7, Canada
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Author to whom correspondence should be addressed.
These authors contributed equally to this work.
J. Risk Financial Manag. 2019, 12(4), 159; https://doi.org/10.3390/jrfm12040159
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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Cheng, Y.; Escobar-Anel, M.; Gong, Z. Generalized Mean-Reverting 4/2 Factor Model. J. Risk Financial Manag. 2019, 12, 159.

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