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Pair trading based on quantile forecasting of smooth transition GARCH models
Chen, C.W.S.,Wang, Z.,Sriboonchitta, S.,Lee, S. JAI Press for the North American Economics and Fin 2017 NORTH AMERICAN JOURNAL OF ECONOMICS AND FINANCE Vol.39 No.-
Pair trading is a statistical arbitrage strategy used on similar assets with dissimilar valuations. We utilize smooth transition heteroskedastic models with a second-order logistic function to generate trading entry and exit signals and suggest two pair trading strategies: the first uses the upper and lower threshold values in the proposed model as trading entry and exit signals, while the second strategy instead takes one-step-ahead quantile forecasts obtained from the same model. We employ Bayesian Markov chain Monte Carlo sampling methods for updating the estimates and quantile forecasts. As an illustration, we conduct a simulation study and empirical analysis of the daily stock returns of 36 stocks from U.S. stock markets. We use the minimum square distance method to select ten stock pairs, choose additional five pairs consisting of two companies in the same industrial sector, and then finally consider pair trading profits for two out-of-sample periods in 2014 within a six-month time frame as well as for the entire year. The proposed strategies yield average annualized returns of at least 35.5% without a transaction cost and at least 18.4% with a transaction cost.
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Pricing chained dynamic fund protection
Han, H.,Jeon, J.,Kang, M. JAI Press for the North American Economics and Fin 2016 NORTH AMERICAN JOURNAL OF ECONOMICS AND FINANCE Vol.37 No.-
In this paper, we propose a new kind of dynamic fund protection (DFP). In contrast to the usual DFP, our newly developed DFP has two protection levels and protection is activated only when the value of underlying asset reaches upper protection levels. This kind of product has a structure similar to that of the chained barrier option proposed by Jun and Ku (2012). In this context, we name our newly designed equity-linked product as chained dynamic fund protection (CDFP). Buying CDFP can be advantageous for both vendors and investors compared to buy usual DFP. Relatively small downside risk for CDFP is beneficial for vendors. Also for investors, the price they cost for protection of CDFP is cheaper than that of usual DFP. Furthermore, investors can handle the price of protection by adjusting the level of upper protection as they desired. In this paper, we derive a closed-form formula for CDFP using reflection principle under Black-Scholes framework. Furthermore, we represent numerical results for values of CDFP according to various parameters.
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Probability of multiple crossings and pricing of double barrier options
Choe, G.H.,Koo, K.H. JAI Press for the North American Economics and Fin 2014 NORTH AMERICAN JOURNAL OF ECONOMICS AND FINANCE Vol.29 No.-
This paper derives pricing formulas of standard double barrier option, generalized window double barrier option and chained option. Our method is based on probabilitic approach. We derive the probability of multiple crossings of curved barriers for Brownian motion with drift, by repeatedly applying the Girsanov theorem and the reflection principle. The price of a standard double barrier option is presented as an infinite sum that converges very rapidly. Although the price formula of standard double barrier option is the same with Kunitomo and Ikeda (1992), our method gives an intuitive interpretation for each term in the infinite series. From the intuitive interpretation we present the way how to approximate the infinite sum in the pricing formula and an error bound for the given approximation. Guillaume (2003) and Jun and Ku (2013) assumed that barriers are constant to price barrier options. We extend constant barriers of window double barrier option and chained option to curved barriers. By employing multiple crossing probabilities and previous skills we derive closed formula for prices of 16 types of the generalized chained option. Based on our analytic formulas we compute Greeks of chained options directly.
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