Abstract

A FINANCIAL MARKET MODEL

Eckhard Platen

University of Technology, Sydney

The paper describes a continuous time equity market model with a minimal number of factors. These factors are powers of Bessel processes. The asset prices are formed by ratios of the factors and have consequently leptokurtic return distributions. Stochastic volatility naturally results with properties that are similar to those typically observed in reality. The model generates for the market index the well-known leverage effect due to negative correlation between the index and its volatility. The model is a complete market model and allows efficient derivative pricing and hedging. Options on the market index show the typical implied volatility skew.