Gravity-Modes in ZZ Ceti Stars: IV. Amplitude Saturation by Parametric Instability

ZZ Ceti stars exhibit small amplitude photometric pulsations in multiple gravity-modes. We demonstrate that parametric instability, a form of resonant 3-mode coupling, limits overstable modes to amplitudes similar to those observed. In particular, it reproduces the observed trend that longer period modes have larger amplitudes. Parametric instability involves the destabilization of a pair of stable daughter modes by an overstable parent mode. The 3-modes must satisfy exact angular selection rules and approximate frequency resonance. The lowest instability threshold for each parent mode is provided by the daughter pair that minimizes $(\delta\omega^2+\gamma_d^2)/\kappa^2$, where $\kappa$ is the nonlinear coupling constant, $\delta\omega$ is the frequency mismatch, and $\gamma_d$ is the energy damping rate of the daughter modes. The overstable mode's amplitude is maintained at close to the instability threshold value. Although parametric instability defines an upper envelope for the amplitudes of overstable modes in ZZ Ceti stars, other nonlinear mechanisms are required to account for the irregular distribution of amplitudes of similar modes and the non-detection of modes with periods longer than 1,200\s. Resonant 3-mode interactions involving more than one excited mode may account for the former. Our leading candidate for the latter is Kelvin-Helmholtz instability of the mode-driven shear layer below the convection zone.Comment: 16 pages with 10 figures, abstract shortened, submitted to Ap

Stochastic Skew in Currency Options

We document the behavior of over-the-counter currency option prices across moneyness, maturity, and calendar time on two of the most actively traded currency pairs over the past eight years. We find that the risk-neutral distribution of currency returns is relatively symmetric on average. However, on any given date, the conditional currency return distribution can show strong asymmetry. This asymmetry varies greatly over time and often switch directions. We design and estimate a class of models that capture these unique features of the currency options prices and perform much better than traditional jump- diffusion stochastic volatility models.currency options, stochastic skew, time-changed Levy processes

What Type of Process Underlies Options? A Simple Robust Test

We develop a simple robust test for the presence of continuous and discontinuous (jump) com­ponents in the price of an asset underlying an option. Our test examines the prices of at­the­money and out­of­the­money options as the option maturity approaches zero. We show that these prices converge to zero at speeds which depend upon whether the sample path of the underlying asset price process is purely continuous, purely discontinuous, or a mixture of both. By applying the test to S&P 500 index options data, we conclude that the sample path behavior of this index contains both a continuous component and a jump component. In particular, we find that while the pres­ence of the jump component varies strongly over time, the presence of the continuous component is constantly felt. We investigate the implications of the evidence for parametric model specifications.Jumps; continuous martingale; option pricing; Levy density; double tails; local time.

Variance Risk Premia

We propose a direct and robust method for quantifying the variance risk premium on financial assets. We theoretically and numerically show that the risk-neutral expected value of the return variance, also known as the variance swap rate, is well approximated by the value of a particular portfolio of options. Ignoring the small approximation error, the difference between the realized variance and this synthetic variance swap rate quantifies the variance risk premium. Using a large options data set, we synthesize variance swap rates and investigate the historical behavior of variance risk premia on five stock indexes and 35 individual stocks.Stochastic volatility, variance risk premia, variance swap, volatility swap, option pricing, expectation hypothesis

Time-Changed Levy Processes and Option Pricing

As is well known, the classic Black­Scholes option pricing model assumes that returns follow Brownian motion. It is widely recognized that return processes differ from this benchmark in at least three important ways. First, asset prices jump, leading to non­normal return innovations. Second, return volatilities vary stochastically over time. Third, returns and their volatilities are correlated, often negatively for equities. We propose that time­changed Levy processes be used to simultaneously address these three facets of the underlying asset return process. We show that our framework encompasses almost all of the models proposed in the option pricing literature. Despite the generality of our approach, we show that it is straightforward to select and test a particular option pricing model through the use of characteristic function technology.random time change; Levy processes; characteristic functions; option pricing; exponen­tial martingales; measure change

The Finite Moment Log Stable Process and Option Pricing

We document a surprising pattern in market prices of S&P 500 index options. When implied volatilities are graphed against a standard measure of moneyness, the implied volatility smirk does not flatten out as maturity increases up to the observable horizon of two years. This behavior contrasts sharply with the implications of many pricing models and with the asymptotic behavior implied by the central limit theorem (CLT). We develop a parsimonious model which deliberately violates the CLT assumptions and thus captures the observed behavior of the volatility smirk over the maturity horizon. Calibration exercises demonstrate its superior performance against several widely used alternatives.Volatility smirk; central limit theorem; Levy a­lpha-stable motion; self­similarity; option pricing.