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

45 Pages Posted: 14 Jan 2021

Date Written: November 8, 2020

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), we use a parameterized ground state wave function (WF) of this QM system as a direct input to the model, which also fixes a non-linear Langevin potential. A stationary distribution of the original Langevin model is given by the square of this WF, and thus is also a direct input to the model. 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. The model produces time-varying variance, skewness and kurtosis of market returns, whose time variability can be linked to probabilities of crisis-like events. For option pricing out of equilibrium, the NES model offers a closed-form approximation by a mixture of three Black-Scholes prices, which can be calibrated to index options data and used to predict moments of future returns. The NES model is shown to be able to describe both regimes of a benign market and a market in a crisis or a severe distress.

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 (November 8, 2020). 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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