Working Papers
Pricing
American-style Basket Options (by Henry Wan)
(Abstract) It is known that the most difficult problem of
pricing and hedging multi-asset basket options are those with
both high dimensionality and early exercise. This article
proposes a numerical algorithm by reducing multivariate distributions
of a portfolio into a single variable and modeling that as
a univariate stochastic process in the form of implied binomial
tree. It is demonstrated that the method provides a fast and
flexible way to pricing and hedging high dimensional multi-asset
basket options with early exercise.
Proxy for Lehman Muni
Index (by Ika Tsitsishvili)
(Abstract)This paper illustrates a practical
implementation of a
cell matching technique for constructing a proxy
portfolio with fewer bonds that closely tracks
various factors of a broad Lehman Muni Index
The Feedback from Stock Prices to Credit Spreads (by Ka Fai Law)
Valuing guaranteed minimum
death benefits in variable annuities and the option
to lapse (by Blessing Mudavanhu).
(Abstract) Many variable annuities provide money-back
guarantees and market guarantees on invested
principal. Embedded in some of these guarantees are
stochastic maturity put options with adjustable
strike prices. These variable annuities can be
surrendered or lapsed at any time. The lapse option
when exercised rationally represents an American style
sell-back option that is exercised by the policyholder
when the embedded put option is out-of-the-money. The
death benefits we consider are only exercised
involuntary, that is, upon the death of the
policyholder. Critical to the valuation analysis is
that the embedded put options have stochastic maturity
and that the policyholder can exercise the lapse, or
early-exercise, option feature to increase the value
of the contract and thereby exposing the insurance
company to loss of fees. We analyze specific variable
annuity products by focusing on the lapse option when
exercised either rationally or irrationally, taking
into account the mortality risk and surrender
charges.
The Impact of Adds and Deletes on the Returns of Stock Indexes (by Jim Quinn and Frank Wang).
The S&P effect is well known. Stocks that are added to the S&P 500 index have in the past exhibited significant positive abnormal returns immediately after the announcement and continued to earn abnormal returns through the effective date of the index change. A portion of the abnormal return has reversed after the effective date.
In this paper we report the results of event studies we performed on additions to the S&P 500 and four other indexes, the S&P 1500, Russell 3000, NASDAQ 100, and Dow Jones Total Market index, for the period 1999-2002. We explore the drag on investment returns that is caused by the reversal of the abnormal return.
A model is also developed that allows an index provider to simulate the consequences of variety of index reconstitution policies on index turnover.
