The Analysis of VAR, Deltas and State Prices: A New Approach
Rodney L. White Center Working Paper No. 11-96
Posted: 17 Oct 1996
Date Written: August 1996
We provide a monotonic transformation of an initial diffusion with a level-dependent diffusion parameter that yields a second, deterministic diffusion parameter process. Altering the diffusion parameter while maintaining the original Brownian motion at the expense of the drift can be viewed as a counterpart to Girsanov's Theorem. The transformed process provides a tractable basis for the analysis of the initial probability distribution, and hence provides insights into the value-at-risk (VAR), hedging and valuation of alternate investment strategies. Restrictions on the initial process imply theoretical bounds on VAR, position deltas and state prices, and an empirical bound on option deltas.
JEL Classification: C63, G11, G13
Suggested Citation: Suggested Citation