Non-Equilibrium Skewness, Market Crises, and Option Pricing: Non-Linear Langevin Model of Markets with Supersymmetry

39 Pages Posted: 14 Jan 2021 Last revised: 27 Dec 2021

Date Written: December 23, 2021

Abstract

This paper presents a tractable model of non-linear dynamics of market returns using a Langevin approach. Due to non-linearity of an interaction potential, the model admits regimes of both small and large return fluctuations. Langevin dynamics are mapped onto an equivalent quantum mechanical (QM) system. Borrowing ideas from supersymmetric quantum mechanics (SUSY QM), a parameterized ground state wave function (WF) of this QM system is used as a direct input to the model, which also fixes a non-linear Langevin potential. Using a two-component Gaussian mixture as a ground state WF with an asymmetric double well potential produces a tractable low-parametric model with interpretable parameters, referred to as the NES (Non-Equilibrium Skew) model. Supersymmetry (SUSY) is then used to find time-dependent solutions of the model in an analytically tractable way. Additional approximations give rise to a final practical version of the NES model, where real-measure and risk-neutral return distributions are given by three component Gaussian mixtures. This produces a closed-form approximation for option pricing in the NES model by a mixture of three Black-Scholes prices, providing accurate calibration to option prices for either benign or distressed market environments, while using only a single volatility parameter.
These results stand in stark contrast to the most of other option pricing models such as local, stochastic, or rough volatility models that need more complex specifications of noise to fit the market data.

Keywords: Non-Equilibrium Market Dynamics, Langevin Dynamics, Non-Perturbative Methods, Quantum Mechanics, Supersymmetry, the Black-Scholes Model

JEL Classification: G10, G11, G12, G13, C00, C02, C32, C50, C51, C52, C58, C60, C62, C65, C68, B23

Suggested Citation

Halperin, Igor, Non-Equilibrium Skewness, Market Crises, and Option Pricing: Non-Linear Langevin Model of Markets with Supersymmetry (December 23, 2021). Available at SSRN: https://ssrn.com/abstract=3724000 or http://dx.doi.org/10.2139/ssrn.3724000

Igor Halperin (Contact Author)

Fidelity Investments, Inc. ( email )

United States

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