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  • HowMuchIsTheGap

    Rights statement: This is an Accepted Manuscript of an article published by Taylor & Francis in Quantitative Finance on 7/3/2017, available online: https://www.tandfonline.com/doi/full/10.1080/14697688.2016.1276299

    Accepted author manuscript, 404 KB, PDF document

    Available under license: CC BY-NC: Creative Commons Attribution-NonCommercial 4.0 International License

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How Much is the Gap?: Efficient Overnight Jump Risk-Adjusted Valuation of Leveraged Certificates

Research output: Contribution to journalJournal article

Published
<mark>Journal publication date</mark>2017
<mark>Journal</mark>Quantitative Finance
Issue number9
Volume17
Number of pages15
Pages (from-to)1387-1401
Publication statusPublished
Early online date7/03/17
Original languageEnglish

Abstract

This paper develops a novel and highly efficient numerical algorithm for the gap risk-adjusted valuation of leveraged certificates. The existing literature relies on Monte Carlo simulations, which are not fast enough to be used in a market making environment. This is because issuers need to compute thousands of price updates per second. By valuing leveraged certificates as multi-window barrier options, we explicitly model random jumps that occur at known times, such as between the exchange closing and re-opening. Our algorithm combines the one-day transition probability with Simpson’s numerical integration rule. This yields a backward induction scheme which requires a significantly coarser spatial and time grid than finite difference methods. We confirm its robustness and accuracy through Monte Carlo simulations.

Bibliographic note

This is an Accepted Manuscript of an article published by Taylor & Francis in Quantitative Finance on 7/3/2017, available online: https://www.tandfonline.com/doi/full/10.1080/14697688.2016.1276299