A Data-Driven Framework for Consistent Financial Valuation and Risk Measurement

51 Pages Posted: 31 Jul 2020

See all articles by Zhenyu Cui

Zhenyu Cui

Stevens Institute of Technology - School of Business

Justin Kirkby

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE)

Duy Nguyen

Marist College - Department of Mathematics

Multiple version iconThere are 2 versions of this paper

Date Written: July 4, 2020

Abstract

In this paper, we propose a general data-driven framework that unifies the valuation and risk measurement of financial derivatives, which is especially useful in markets with thinly-traded derivatives. We first extract the empirical characteristic function from market-observable time series for the underlying asset prices, and then utilize Fourier techniques to obtain the physical non-parametric density and cumulative distribution function for the log-returns process, based on which we compute risk measures.

Then we risk-neutralize the non-parametric density and distribution functions to model-independently valuate a variety of financial derivatives, including path-independent European options and path-dependent exotic contracts. By estimating the state-price density explicitly, and utilizing a convenient basis representation, we are able to greatly simplify the pricing of exotic options all within a consistent model-free framework.

Numerical examples, and an empirical example using real market data (Brent crude oil prices) illustrate the accuracy and versatility of the proposed method in handling pricing and risk management of multiple financial contracts based solely on observable time series data.

Keywords: Finance, Risk Management, Data-Driven, Non-Parametric, Empirical Characteristic Function, Empirical Density, Model-Free

JEL Classification: C14, G13, G17, C58, C53, C01

Suggested Citation

Cui, Zhenyu and Kirkby, Justin and Nguyen, Duy, A Data-Driven Framework for Consistent Financial Valuation and Risk Measurement (July 4, 2020). Available at SSRN: https://ssrn.com/abstract=3643527 or http://dx.doi.org/10.2139/ssrn.3643527

Zhenyu Cui

Stevens Institute of Technology - School of Business ( email )

Hoboken, NJ 07030
United States

HOME PAGE: http://sites.google.com/site/zhenyucui86/publications

Justin Kirkby (Contact Author)

Georgia Institute of Technology - The H. Milton Stewart School of Industrial & Systems Engineering (ISyE) ( email )

765 Ferst Drive
Atlanta, GA 30332-0205
United States

Duy Nguyen

Marist College - Department of Mathematics ( email )

NY
United States

HOME PAGE: http://sites.google.com/site/nducduy/

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