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Section: Research Program

Dependence modeling

Participants : Aurélien Alfonsi, Damien Lamberton, Bernard Lapeyre.

The volatility is a key concept in modern mathematical finance, and an indicator of the market stability. Risk management and associated instruments depend strongly on the volatility, and volatility modeling has thus become a crucial issue in the finance industry. Of particular importance is the assets dependence modeling. The calibration of models for a single asset can now be well managed by banks but modeling of dependence is the bottleneck to efficiently aggregate such models. A typical issue is how to go from the individual evolution of each stock belonging to an index to the joint modeling of these stocks. In this perspective, we want to model stochastic volatility in a multidimensional framework. To handle these questions mathematically, we have to deal with stochastic differential equations that are defined on matrices in order to model either the instantaneous covariance or the instantaneous correlation between the assets. From a numerical point of view, such models are very demanding since the main indexes include generally more than thirty assets. It is therefore necessary to develop efficient numerical methods for pricing options and calibrating such models to market data. As a first application, modeling the dependence between assets allows us to better handle derivatives products on a basket. It would give also a way to price and hedge consistenly single-asset and basket products. Besides, it can be a way to capture how the market estimates the dependence between assets. This could give some insights on how the market anticipates the systemic risk.