Stochastic Correlation and Volatility Mean-reversion - Empirical Motivation and Derivatives Pricing via Perturbation Theory

The dependence structure is crucial when modeling several assets simultaneously. We show for a real-data example that the correlation structure between assets is not constant over time but rather changes stochastically, and we propose a multidimensional asset model which fits the patterns found in the empirical data. The model is applied to price multi-asset derivatives by means of perturbation theory. It turns out that the leading term of the approximation corresponds to the Black-Scholes derivative price with correction terms adjusting for stochastic volatility and stochastic correlation effects. The practicability of the presented method is illustrated by some numerical implementations.     «

The dependence structure is crucial when modeling several assets simultaneously. We show for a real-data example that the correlation structure between assets is not constant over time but rather changes stochastically, and we propose a multidimensional asset model which fits the patterns found in the empirical data. The model is applied to price multi-asset derivatives by means of perturbation theory. It turns out that the leading term of the approximation corresponds to the Black-Scholes deriv...     »