Final Exam FE621
Posted May 11, 2020, Due May 18, 2020 at 9:00am
Name:
• Please note: for the problems using data we are not interested in all the
minor steps performed when analyzing the data. However, you should
explain your broad reasoning and hand in a final report.
• Do not include any failed attempts at modeling just to give volume to the
final report.
• You need to argument with graphs or selected numerical results all the
conclusions you draw. Put important plots and tables within the report
and relegate any non essential ones to an appendix at the end of the
document.
• Please add supporting arguments (e.g., output) in the appendix. The
whole report should be constructed as a regular journal article.
• The final write-up (excluding the appendix) should not be more than 10-15
pages.
• Communication with other students either physical or virtual is strictly
forbidden.
For instructor’s use only
Problem Points Score
A 100
B 100
C 100
Bonus 1 5
Bonus 2 25
Total 300
(b) Implement a Monte Carlo scheme to price an arithmetic Asian call option
(P sima ). Use M = 1, 000, 000 simulations. Record the answer, a confidence
interval and the time it takes to obtain the result.
(c) Implement a Monte Carlo scheme to price a geometric Asian Call option
(P simg ).
(d) Using M = 10, 000 simulations and the same exact random variables create:
• numbers Xi which are M replications for the arithmetic Asian Option
Problem B. Using fractional Brownian motion in finance. For this
problem we will look at a process called the fractional Brownian motion (fBm).
For a simple introduction please see [1]. The formal definition and properties
of the fBM are given on page 6 in the thesis [1]. For a deeper understanding of
the calculus needed to work with fBm please see Eulalia Nualart notes [2]. You
will not need to have a deep understanding of the topic for this problem. Just
the definitions provided are fine.
(a) Simulate a fBM using the Davies and Harte method, see section 2.1.3 in
[1] and pay special attention to the algorithm presented on page 17. Plot
four sample paths, each having different values of the Hurst parameter:
H ∈ {0.2, 0.5, 0.6, 0.9}. Consider T = 1 with n = 2000 time steps. You may
use any package or toolbox that returns the FFT of a given vector. Please
describe the way in which the sample path changes with H.
Bonus 1 Use the python package described in [3]. This is a package written by one
of our Ph.D. students which implements several methods of generating fBm
paths. This part is optional as it needs python and we do not know if python
code is accessible from other languages. Check the answers you obtained in
part (a) with the package results.
(b) At the beginning of 2000’s the observed dependence structure of log–returns
was modeled using an fBm process. Specifically, consider a regular geometric
Brownian motion model, with Wt replaced by an fBm Zt, having E[Z2t ] =
t2H :
dSt = St(rdt+ σdZt), S(0) = S0.
Please note that when H = 12 the fBm becomes a standard Brownian mo-
tion. Thus, this model is an extension of the Black-Scholes-Merton settings.
Price a European call option under this model, with S0 = K = 100, T = 1,
r = 5%, and σ = 20%. Use a Monte Carlo simulation with an Euler
discretization. Consider at least 1 million paths and four different values
of the Hurst parameter, i.e. H ∈ {0.2, 0.5, 0.6, 0.9}. Compare with the
result obtained using the classical Black–Scholes model. Please describe
your observations.
Bonus 2 Implement or use an implementation to estimate the Hurst parameter using
the Rescaled range analysis (R/S method). This is described in section
3.1.7 of the thesis [1], but it is a straightforward methods that even has
a wikipedia page. There are numerous packages in many programming
languages that implement this method but you can also implement it if you
wish.
Use the function you created in (a) or the Bonus 1 function to generate
fBm paths with a known H. Use the R/S implementation to estimate H.
Compare the values (true and estimate) to verify your code is correct.
Download historical (daily) closing prices for an equity picked by you for 24
months. Report the estimated Hurst parameter value and comment.