# Publikationer

Publikationer i högskolans databas.

## Latest publications

- Approximation Methods of European Option Pricing in Multiscale Stochastic Volatility Model
In the classical Black-Scholes model for financial option pricing, the asset price follows a geometric Brownian motion with constant volatility. Empirical findings such as volatility smile/skew, fat-tailed asset return distributions have suggested that the constant volatility assumption might not be realistic. A general stochastic volatility model, e.g. Heston model, GARCH model and SABR volatility model , in which the variance/volatility itself follows typically a mean-reverting stochastic process, has shown to be superior in terms of capturing the empirical facts. However in order to capture more features of the volatility smile a two-factor, of double Heston type, stochastic volatility model is more useful as shown by Christoffersen, Heston and Jacobs. We consider one specific type of such two-factor volatility models in which the volatility has multiscale mean-reversion rates. Our model contains two mean-reverting volatility processes with a fast and a slow reverting rate respectively. We consider the European option pricing problem under one type of the multiscale stochastic volatility model where the two volatility processes act as independent factors in the asset price process. The novelty in this chapter is an approximating analytical solution using asymptotic expansion method which extends the authors earlier research in Canhanga et al. In addition we propose a numerical approximating solution using Monte-Carlo simulation. For completeness and for comparison we also implement the semi-analytical solution by Chiarella and Ziveyi using method of characteristics, Fourier and bivariate Laplace transforms.

- Numerical Methods on European Options Second Order Asymptotic Expansions for Multiscale Stochastic Volatility
After Black-Scholes proposed a model for pricing European Option in 1973, Cox, Ross and Rubinstein in 1979, and Heston in 1993, showed that the constant volatility assumption in the Black-Scholes model was one of the main reasons for the model to be unable to capture some market details. Instead of constant volatilities, they introduced non-constant volatilities to the asset dynamic modeling. In 2009, Christoffersen empirically showed "why multi-factor stochastic volatility models work so well". Four years later, Chiarella and Ziveyi solved the model proposed by Christoffersen. They considered an underlying asset whose price is governed by two factor stochastic volatilities of mean reversion type. Applying Fourier transforms, Laplace transforms and the method of characteristics they presented an approximate formula for pricing American option.The huge calculation involved in the Chiarella and Ziveyi approach motivated us to investigate another approach to compute European option prices on a Christoffersen type model. Using the first and second order asymptotic expansion method we presented a closed form solution for European option, and provided experimental and numerical studies on investigating the accuracy of the approximation formulae given by the first order asymptotic expansion. In the present chapter we will perform experimental and numerical studies for the second order asymptotic expansion and compare the obtained results with results presented by Chiarella and Ziveyi.

- A Random Field Formulation of Hooke’s Law in All Elasticity Classes
For each of the 8 symmetry classes of elastic materials, we consider a homogeneousrandom field taking values in the fixed point set V of the corresponding class, that is isotropic with respect to the natural orthogonal representation of a group lying between the isotropy group of the class and its normaliser. We find the general form of the correlation tensors of orders 1 and 2 of such a field, and the field’s spectral expansion.

- Matérn Class Tensor-Valued Random Fields and Beyond
We construct classes of homogeneous random fields on a three-dimensional Euclidean space that take values in linear spaces of tensors of a fixed rank and are isotropic with respect to a fixed orthogonal representation of the group of 3 × 3 orthogonal matrices.The constructed classes depend on finitely many isotropic spectral densities. We say that such a field belongs to either the Matérn or the dual Matérn class if all of the above densities are Matérn or dual Matérn. Several examples are considered.

- Algorithms of the Copula Fit to the Nonlinear Processes in the Utility Industry
Our research studies the construction and estimation of copula-based semi parametric Markov model for the processes, which involved in water flows in the hydro plants. As a rule analyzing the dependence structure of stationary time series regressive models defined by invariant marginal distributions and copula functions that capture the temporal dependence of the processes is considered. This permits to separate out the temporal dependence (such as tail dependence) from the marginal behavior (such as fat tails) of a time series. Dealing with utility company data we have found the best copula describing data - Gumbel copula. As a result constructed algorithm was used for an imitation of low probability events (in a hydro power industry) and predictions.

- Spectral expansions of tensor-valued random fields
In this paper, we review the theory of random fields that are defined on the space domain ℝ3, take values in a real finite-dimensional linear space V that consists of tensors of a fixed rank, and are homogeneous and isotropic with respect to an orthogonal representation of a closed subgroup G of the group O(3). A historical introduction, the statement of the problem, some current results, and a sketch of proofs are included.

- Numerical Studies on Asymptotics of European Option Under Multiscale Stochastic Volatility
Multiscale stochastic volatilities models relax the constant volatility assumption from Black-Scholes option pricing model. Such models can capture the smile and skew of volatilities and therefore describe more accurately the movements of the trading prices. Christoffersen et al. Manag Sci 55(2):1914–1932 (2009) presented a model where the underlying price is governed by two volatility components, one changing fast and another changing slowly. Chiarella and Ziveyi Appl Math Comput 224:283–310 (2013) transformed Christoffersen’s model and computed an approximate formula for pricing American options. They used Duhamel’s principle to derive an integral form solution of the boundary value problem associated to the option price. Using method of characteristics, Fourier and Laplace transforms, they obtained with good accuracy the American option prices. In a previous research of the authors (Canhanga et al. 2014), a particular case of Chiarella and Ziveyi Appl Math Comput 224:283–310 (2013) model is used for pricing of European options. The novelty of this earlier work is to present an asymptotic expansion for the option price. The present paper provides experimental and numerical studies on investigating the accuracy of the approximation formulae given by this asymptotic expansion. We present also a procedure for calibrating the parameters produced by our first-order asymptotic approximation formulae. Our approximated option prices will be compared to the approximation obtained by Chiarella and Ziveyi Appl Math Comput 224:283–310 (2013).

- Fractal planetary rings: energy inequalities and random field model
This study is motivated by a recent observation, based on photographs from the Cassini mission, that Saturn’s rings have a fractal structure in radial direction. Accordingly, two questions are considered: (1) What Newtonian mechanics argument in support of such a fractal structure of planetary rings is possible? (2) What kinematics model of such fractal rings can be formulated? Both challenges are based on taking planetary rings’ spatial structure as being statistically stationary in time and statistically isotropic in space, but statistically nonstationary in space. An answer to the first challenge is given through an energy analysis of circular rings having a self-generated, noninteger-dimensional mass distribution [V. E. Tarasov,

*Int. J. Mod Phys. B***19**, 4103 (2005)]. The second issue is approached by taking the random field of angular velocity vector of a rotating particle of the ring as a random section of a special vector bundle. Using the theory of group representations, we prove that such a field is completely determined by a sequence of continuous positive-definite matrix-valued functions defined on the Cartesian square F^2 of the radial cross-section F, where F is a fat fractal. - Spectral expansions of homogeneous and isotropic tensor-valued random fields
We establish spectral expansions of tensor-valued homogeneous and isotropic random fields in terms of stochastic integrals with respect to orthogonal scattered random measures previously known only for the case of tensor rank 0. The fields under consideration take values in the 3-dimensional Euclidean space E3 and in the space S2(E3) of symmetric rank 2 tensors over E3. We find a link between the theory of random fields and the theory of finite-dimensional convex compact sets. These random fields furnish stepping-stone for models of rank 1 and rank 2 tensor-valued fields in continuum physics, such as displacement, velocity, stress, strain, providing appropriate conditions (such as the governing equation or positive-definiteness) are imposed.

- Sensitivity Analysis of Catastrophe Bond Priceunder the Hull–White Interest Rate Model
We consider a model, where the natural risk index is described by the Merton jump-diffusion while the risk-free interest rate is governed by the Hull–White stochastic differential equation. We price a catastrophe bond with payoff depending on finitely many values of the underlying index. The sensitivities of the bond price with respect to the initial condition, volatility of the diffusion component, and jump amplitude, are calculated using the Malliavin calculus approach.

- Spectral Expansion of Three-Dimensional Elasticity Tensor Random Fields
We consider a random field model of the 21-dimensional elasticity tensor. Representation theory is used to obtain the spectral expansion of the model in terms of stochastic integrals with respect to random measures.

- Scaling to RVE in Random Media
The problem of effective properties of material microstructures has received considerableattention over the past half a century. By effective (or overall, macroscopic, global) ismeant the response assuming the existence of a representative volume element (RVE)on which a homogeneous continuum is being set up. Since the efforts over the pastquarter century have been shifting to the problem of the size of RVE, this chapterreviews the results and challenges in this broad field for a wide range of materials.For the most part, the approach employed to assess the scaling to the RVE is basedon the Hill–Mandel macrohomogeneity condition. This leads to bounds that explicitlyinvolve the size of a mesoscale domain—this domain also being called a statisticalvolume element (SVE)—relative to the microscale and the type of boundary conditionsapplied to this domain. In general, the trend to pass from the SVE to RVE depends onrandom geometry and mechanical properties of the microstructure, and displayscertain, possibly universal tendencies. This chapter discusses that issue first for linearelastic materials, where a scaling function plays a key role to concisely grasp theSVE-to-RVE scaling. This sets the stage for treatment of nonlinear and or/inelastic randommaterials, including elasto-plastic, viscoelastic, permeable, and thermoelasticclasses. This methodology can be extended to homogenization of random media bymicropolar (Cosserat) rather than by classical (Cauchy) continua as well as to homogenizationunder stationary (standing wave) or transient (wavefront) loading conditions.The final topic treated in this chapter is the formulation of continuum mechanicsaccounting for the violations of second law of thermodynamics, which have been studied on a molecular level in statistical physics over the past two decades. We end with anoverview of open directions and challenges of this research field.

- Tensor-Valued Random Fields in Continuum Physics
This article reports progress on homogeneous isotropic tensor random fields (TRFs) for continuum mechanics. The basic thrust is on determinin most general representations of the correlation functions as well as their spectral expansions. Once this is accomplished, the second step is finding the restrictionsdictated by a particular physical application. Thus, in the case of fields of material properties (like conductivity and stiffness), the restriction resides in the positive-definiteness, whereby a connection to experiments and/or computational micromechanics can be established. On the other hand, in the case of fields of dependent properties (e.g., stress, strain and displacement), restrictions are due to the respective field equations.

- Pricing European Options Under Stochastic Volatilities Models
Interested by the volatility behavior, different models have been developed for option pricing. Starting from constant volatility model which did not succeed on capturing the effects of volatility smiles and skews; stochastic volatility models appearas a response to the weakness of the constant volatility models. Constant elasticity of volatility, Heston, Hull and White, Schöbel-Zhu, Schöbel-Zhu-Hull-Whiteand many others are examples of models where the volatility is itself a random process. Along the chapter we deal with this class of models and we present the techniques of pricing European options. Comparing single factor stochastic volatility models to constant factor volatility models it seems evident that the stochastic volatility models represent nicely the movement of the asset price and its relations with changes in the risk. However, these models fail to explain the large independent fluctuations in the volatility levels and slope. Christoffersen et al. in [4] proposed a model with two-factor stochastic volatilities where the correlation between the underlying asset price and the volatilities varies randomly. In the last section of this chapter we introduce a variation of Chiarella and Ziveyi model, which is a subclass of the model presented in [4] and we use the first order asymptotic expansion methods to determine the price of European options.

- Sensitivity analysis of catastrophe bond price under the hull-white interest rate model
We consider a model, where the natural risk index is described by the Merton jump-diffusion while the risk-free interest rate is governed by theHull-White stochastic differential equation. We price a catastrophe bond with payoff depending on finitely many values of the underlying index. The sensitivities of the bond price with respect to the initial condition, volatility of the diffusion component, and jump amplitude, are calculated using the Malliavin calculus approach.

- Spectral expansions of cosmological fields
We give a review of the theory of random fields defined on the observable part of the Universe that satisfy the cosmological principle, i.e.,invariant with respect to the 6-dimensional group G of theisometries of the time slice of theFriedmann-Lemaitre-Robertson-Walker standard chart. Our new results include proof of spectral expansions of scalar and spin weighted G-invariant cosmological fields in open, flat, and closed cosmological models.

- Perturbation Methods for Pricing European Options in a Model with Two Stochastic Volatilities
Financial models have to reflect the characteristics of markets in which they are developed to be able to predict the future behavior of a financial system. The nature of most trading environments is characterized by uncertainties which are expressed in mathematical models in terms of volatilities. In contrast to the classical Black-Scholes model with constant volatility, our model includes one fast-changing and another slow-changing stochastic volatilities of mean-reversion type. The different changing frequencies of volatilities can be interpreted as the effects of weekends and effects of seasons of the year (summer and winter) on the asset price.

We perform explicitly the transition from the real-world to the risk-neutral probability measure by introducing market prices of risk and applying Girsanov Theorem. To solve the boundary value problem for the partial differential equation that corresponds to the case of a European option, we perform both regular and singular multiscale expansions in fractional powers of the speed of mean-reversion factors. We then construct an approximate solution given by the two-dimensional Black-Scholes model plus some terms that expand the results obtained by Black and Scholes.

- Numerical Studies on Asymptotics of European Option under Multiscale Stochastic Volatility
Multiscale stochastic volatilities models relax the constant volatility assumption from Black-Scholes option pricing model. Such model can capture the smile and skew of volatilities and therefore describe more accurately the movements of the trading prices. Christoffersen et al. [3] presented a model where the underlying priceis governed by two volatility components, one changing fast and another changing slowly. Chiarella and Ziveyi [2] transformed Christoffersen’s model and computed an approximate formula for pricing American options. They used Duhamel’s principle to derive an integral form solution of the boundary value problem associated to the option price. Using method of characteristics, Fourier and Laplace transforms, they obtained with good accuracy the American options prices. In a previous research of the authors (Canhanga et al. [1]), a particular case of Chiarella and Ziveyi [2] model is used for pricing of European options. The novelty of this earlier work is to present an asymptotic expansion for the option price. The present paper provides experimental and numerical studies on investigating the accuracy of the approximation formulae given by this asymptotic expansion. We present also a procedure for calibrating the parameters produced by our first-order asymptotic approximation formulae. Our approximated option prices will be compared to the approximation obtained by Chiarella and Ziveyi [2].

1. Canhanga B., Malyarenko, A., Ni, Y. and Silvestrov S. Perturbation methods for pricing European options in a model with two stochastic volatilities. 3rd SMTDA Conference Proceedings. 11-14 June 2014, Lisbon Porturgal, C. H. Skiadas (Ed.) 489-500 (2014).

2. Chiarella, C, and Ziveyi, J. American option pricing under two stochastic volatility processes. J. Appl. Math. Comput. 224:283–310 (2013).

3. Christoffersen, P.; Heston, S.; Jacobs, K. The shape and term structure of the index option smirk: why multifactor stochastic volatility models work so well. Manage. Sci. 55 (2) 1914-1932; (2009).

- Second Order Asymptotic Expansion for Pricing European Options in a Model with Two Stochastic Volatilities
Asset price processes with stochastic volatilities have been actively used by researchers in financial mathematics for valuing derivative securities. This type of models allows characterizing the uncertainties in the asset price process in financial markets. In a recent paper Chiarella and Ziveyi analyzed a model with two stochastic volatilities of mean reversion type with one variable changing fast and the other changing slowly. They used method of characteristics to solve the obtained partial differential equation and determine the price of an American option. Fouque et al presented also a similar model in which the volatility of the underlying asset is governed by two diffusion processes which are not of mean reversion type. They developed a first-order asymptotic expansion for the European option price via a perturbation method.

In this chapter we consider the model given in Chiarella and Ziveyi. Instead of pricing American options we price European options by generalizing the techniques presented in Fouque et al to a more complex model with mean reverting stochastic volatility factors. We analyse both regular and singular perturbations to obtain an asymptotic expansion up to second order which can serve as an approximation for the price of non-path-dependent European options. Similar work is done in authors earlier work Canhanga et al where a first-order asymptotic expansion has been developed. Involving the second order terms has the advantage of capturing more accurately the effects of volatility smile and skew on the option pricing. Analytical approximation formula for pricing European Option is presented.

- Modelling electricity price series using regime-switching GARCH model
This paper implements and analyzes the Regime-Switching GARCH modelusing real NordPool Electricity spot data. We allow the model parameters to switch between a regular regime and a non-regular regime, which is justied by a so-called structural break behaviour of electricity price series. In splitting the two regimes we consider three criteria, namely the intercountry price difference criterion, the capacity/flow difference criterion and the spikes-in-Finland criterion. We study the correlation relationships among these criteria using the mean-square contingency coefficient and the co-occurrence measure. We also estimate our model parameters and present empirical validity of the model.