Beruflich Dokumente
Kultur Dokumente
2
Math6911, S08, HM ZHU
3. Monte Carlo Simulations
3.1 Overview
9
Math6911, S08, HM ZHU
Outlines
1. Markov process
2. Wiener process
3. Generalized Wiener process
4. Ito’s process, Ito’s lemma
5. Asset price models
10
Math6911, S08, HM ZHU
References
11
Math6911, S08, HM ZHU
Markov process
13
Math6911, S08, HM ZHU
Weak-Form Market Efficiency
∆x = a ∆t + b ε ∆t
• Mean change in x in time ∆t is a ∆t
• Variance of change in x in time ∆t is b2 ∆t
• Standard deviation of change in x in time ∆t
is b ∆t
∆x = a T + b ε T
• Mean change in x in time T is aT
• Variance of change in x in time T is b2T
• Standard deviation of change in x in time T
is
b T
dS = µ S dt + σ S dz Itô’s process
∆ S = µS ∆ t + σS ε ∆ t
30
Math6911, S08, HM ZHU
Example: Simulate stock prices
31
Math6911, S08, HM ZHU
Itô’s Lemma (See pages 273-274, Hull)
∂G ∂G ∂ 2G
∆G = ∆x + ∆t + ½ ∆ x 2
∂x ∂t ∂x 2
∂ 2G ∂ 2G 2
+ ∆x ∆t + ½ ∆t + …
∂x∂t ∂t 2
Suppose
dx = a( x, t )dt + b( x, t )dz
so that
∆x = a ∆t + b ε ∆t
Then ignoring terms of higher order than ∆t
∂G ∂G ∂G 2 22
∆G = ∆x + ∆t + ½ 2 b ε ∆t
∂x ∂t ∂x
Math6911, S08, HM ZHU
The ε2∆t Term
Since ε ≈ N (0,1), E (ε ) = 0
E (ε 2 ) − [E (ε )]2 = 1
E (ε ) = 1
2
It follows that E (ε 2 ∆t ) = ∆t
The variance of ∆t is proportional to ∆t 2 and can
be ignored. Hence
∂G ∂G 1 ∂ 2G 2
∆G = ∆x + ∆t + b ∆t
∂x ∂t 2∂x 2
∂G ∂G ∂ 2G 2
Taking limits dG = dx + dt + ½ 2 b dt
∂x ∂t ∂x
Substituti ng dx = a dt + b dz
⎛ ∂G ∂G ∂ 2G 2 ⎞ ∂G
We obtain dG = ⎜⎜ a+ + ½ 2 b ⎟⎟ dt + b dz
⎝ ∂x ∂t ∂x ⎠ ∂x
This is Ito' s Lemma
If G = ln S, then
dG = ?
⎛ σ2 ⎞
dG = ⎜ µ − ⎟ dt + σ dz
⎝ 2 ⎠
40
Math6911, S08, HM ZHU
Lognormal Distribution
(
E S (t ) ) ( 2 µ +σ ) t
2
2
=S e2
0
42
Math6911, S08, HM ZHU
Models for stock price in risk neutral
world (r: risk-free interest rate)
( )
d lnS = r − σ 2 / 2 dt + σ dz
or (2)
( )
lnS(t + ∆t ) − lnS(t ) = r − σ 2 / 2 ∆t + σε ∆t
43
Math6911, S08, HM ZHU
Which one is more accurate?
44
Math6911, S08, HM ZHU
3. Monte Carlo Simulation
Note :
- It is from Central Limit Theorem.
- The approximation is satisfactory for most purposes
Consider the sum :Sn = X1 + ... + Xn. Then the expected value of Sn
is nμ and its standard deviation is σ n½. Furthermore, informally
speaking, the distribution of Sn approaches the normal distribution
N(nμ,σn1/2) as n approaches ∞.
Var ( X ) =
12
Math6911, S08, HM ZHU
Generate Samples from N(0,1):
Box-Muller algorithm
Note:
- Box and Muller (1958), Ann. Math. Statist., 29:610-611
- Common and more efficient than the previous method.
- But it is costly to evaluate trigonometric functions
Math6911, S08, HM ZHU
Generate Samples from N(0,1):
Improved Box-Muller algorithm
Note:
- Ahrens and Dieter (1988), Comm. ACM 31:1330-1337
Math6911, S08, HM ZHU
Question
S ( t + ∆t ) = S ( t ) e
( µˆ −σ
i i
2
)
/ 2 ∆t +σ i ε i ∆t
i i
60
Math6911, S08, HM ZHU
3. Monte Carlo Simulation
M − 1 i=1
σ2
E ⎡⎢( X ( M ) − µ ) ⎤⎥ = Var ⎡⎣ X ( M ) ⎤⎦ =
2
: the expected value of square error
⎣ ⎦ M
as a way to quantify the quality of our estimator
Note that σ 2 can be estimated by the sample variance S 2 ( M )
σ S2 (M )
≈
M M
X ( M ) − z1−α / 2
S 2
(M ) < µ < X S 2
(M )
( M ) + z1−α / 2
M M
where z1−α / 2 is the critical number from the standard
normal distribution.
Note: Uncertainty is inverse proportional to the square
root of the number of trials
S2 (M ) S2 (M )
X ( M ) − 1.96 < µ < X ( M ) + 1.96
M M
73
Math6911, S08, HM ZHU
Determining Greek Letters
For ∆:
1. Make a small change to asset price
2. Carry out the simulation again using the same random number streams
3. Estimate ∆ as the change in the option price divided by the change in
the asset price
VMC* −VMC
∆S
Assume:
n + 1: number of observation at fixed time interval
Si : Stock price at end of ith (i = 0, 1, ..., n) interval
∆t : Length of observing time interval in years
⎛ Si ⎞
ui = ln ⎜ ⎟ : n number of approximation for the change
⎝ Si −1 ⎠
of ln S over ∆t
77
Math6911, S08, HM ZHU
Estimate volatility σ from historical
data
Compute the standard deviation of the u i ' s :
1
∑ ( ui − u )
n
s=
2
n −1 i =1
Note:
1. Monte-Carlo works when the simulated variables "spread out" as closely
as possible to the true distribution.
2. Antithetic variates relies upon finding samplings that are anticorrelated
with the original random variable.
3. Works well when the payoff is monotonic w.r.t. S
4. Further reading:
--P.P. Boyle, Option: a Monte Carlo approach, J. of Finanical Economics,
4:323-338 (1977)
--Boyle, Broadie and Glasserman, Monte Carlo methods for security pricing
J. of Economic Dynamics and Control, 21: 1267-1321 (1997)
--N. Madras, Lectures on Monte Carlo Methods, 2002
Math6911, S08, HM ZHU
Example: European call
88
Math6911, S08, HM ZHU
Control Variate Technique
s
where m and s are the mean and standard deviation of samples.
The adjusted samples ε i* has the correct mean 0 and standard deviation 1.
1
• The standard error of the estimate is proportional to
M
• www.mcqmc.org
• www.mat.sbg.ac.at/~schmidw/links.html
Appendix
99
Math6911, S08, HM ZHU
Asian Options (Chapter 22)
S ave = N S ( t1 ) S ( t2 ) S (tN )
10
Math6911, S08, HM ZHU 0
Asian Options (geometric
averaging)
10
Math6911, S08, HM ZHU 1
Asian Options (arithmetic
averaging)
• No analytic solution
• Can be valued by assuming (as an
approximation) that the average stock price
is lognormally distributed
• Turnbull and Wakeman, 1991, J. of
Financial and Quantitative Finance, 26:377-
389
• Levy,1992, J. of International Money and
Finance, 14:474-491
10
Math6911, S08, HM ZHU 2
Example: Asian Put with arithmetric
average
10
Math6911, S08, HM ZHU 3