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Stochastic modelling of financial processes with memory and semi-heavy tails

By Chatchai Pesee

Abstract

This PhD thesis aims to study financial processes which have semi-heavy-tailed marginal distributions and may exhibit memory. The traditional Black-Scholes model is expanded to incorporate memory via an integral operator, resulting in a class of market models which still preserve the completeness and arbitragefree conditions needed for replication of contingent claims. This approach is used to estimate the implied volatility of the resulting model. The first part of the thesis investigates the semi-heavy-tailed behaviour of financial processes. We treat these processes as continuous-time random walks characterised by a transition probability density governed by a fractional Riesz- Bessel equation. This equation extends the Feller fractional heat equation which generates a-stable processes. These latter processes have heavy tails, while those processes generated by the fractional Riesz-Bessel equation have semi-heavy tails, which are more suitable to model financial data. We propose a quasi-likelihood method to estimate the parameters of the fractional Riesz- Bessel equation based on the empirical characteristic function. The second part considers a dynamic model of complete financial markets in which the prices of European calls and puts are given by the Black-Scholes formula. The model has memory and can distinguish between historical volatility and implied volatility. A new method is then provided to estimate the implied volatility from the model. The third part of the thesis considers the problem of classification of financial markets using high-frequency data. The classification is based on the measure representation of high-frequency data, which is then modelled as a recurrent iterated function system. The new methodology developed is applied to some stock prices, stock indices, foreign exchange rates and other financial time series of some major markets. In particular, the models and techniques are used to analyse the SET index, the SET50 index and the MAI index of the Stock Exchange of Thailand

Topics: Alpha stable distribution, L´evy distribution, the Feller fractional heat equation, the Riesz-Bessel distribution, volatility, the Anh-Inoue model, the tick test, recurrent iterated function systems, memory, semi-heavy tails, long-range dependence, fractional Brownian motion
Publisher: Queensland University of Technology
Year: 2005
OAI identifier: oai:eprints.qut.edu.au:16057

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