Multiple subordinated modeling of asset returns: Implications for option pricing. (19th April 2021)

• Record Type: Journal Article
• Authors: Shirvani, Abootaleb; Rachev, Svetlozar T.; Fabozzi, Frank J.
• Is Part Of: Econometric reviews. Volume 40:Number 3(2021)
• Page Start: 290
• Page End: 319
• Publication Date: 2021-04-19
• Subjects: Behavioral finance -- dynamic asset pricing models -- Lévy-stable distribution -- normal-compound inverse Gaussian distribution -- variance-gamma-gamma distribution; C02 -- G10 -- G12 -- G13 -- G40; Econometrics -- Periodicals; 330.015195
• DOI: 10.1080/07474938.2020.1781404
• Languages: English
• ISSNs: 0747-4938

Abstract

Abstract: Motivated by behavioral finance, we introduce multiple embedded financial time clocks. Consistent with asset pricing theory in analyzing equity returns, the investors' view is considered by introducing a behavioral subordinator. Subordinating to the Brownian motion process in the log-normal model results in a new log-price process whose parameter is as important as the mean and variance. We describe new distributions, demonstrating their use to model tail behavior. The models are applied to S&P 500 returns, treating the Chicago Board Options Exchange (CBOE) volatility index (VIX) as intrinsic-time change and CBOE Volatility-of-Volatility Index as the volatility subordinator. We find these volatility indexes fail as time-change subordinators. We employ a double subordinator model to explain the equity premium puzzle and the excess volatility puzzle. The results indicate the puzzles can be explained by fitting a double subordinator model to the historical data.