arXiv subjects

Jean-Philippe Bouchaud

Publications and source records attributed to Jean-Philippe Bouchaud.

At least 253 records · Page 14Linked to original sources

arXiv2000

Hedged Monte-Carlo: low variance derivative pricing with objective probabilities

We propose a new `hedged' Monte-Carlo (HMC) method to price financial derivatives, which allows to determine simultaneously the optimal hedge. The inclusion of the optimal hedging strategy allows one to reduce the financial risk associated with option trading, and for the very same reason reduces considerably the variance of our HMC scheme as compared to previous methods. The explicit accounting of the hedging cost naturally converts the objective probability into the `risk-neutral' one. This allows a consistent use of purely historical time series to price derivatives and obtain their residual risk. The method can be used to price a large class of exotic options, including those with path dependent and early exercise features.

cond-mat↗

arXiv2000

Power-laws in economy and finance: some ideas from physics

We discuss several models in order to shed light on the origin of power-law distributions and power-law correlations in financial time series. From an empirical point of view, the exponents describing the tails of the price increments distribution and the decay of the volatility correlations are rather robust and suggest universality. However, many of the models that appear naturally (for example, to account for the distribution of wealth) contain some multiplicative noise, which generically leads to *non universal exponents*. Recent progress in the empirical study of the volatility suggests that the volatility results from some sort of multiplicative cascade. A convincing `microscopic' (i.e. trader based) model that explains this observation is however not yet available. It would be particularly important to understand the relevance of the pseudo-geometric progression of natural human time scales on the long range nature of the volatility correlations.

cond-mat↗

arXiv2000

Population dynamics in a random environment

We investigate the competition between barrier slowing down and proliferation induced superdiffusion in a model of population dynamics in a random force field. Numerical results in $d=1$ suggest that a new intermediate diffusion behaviour appears. We introduce the idea of proliferation assisted barrier crossing and give a Flory like argument to understand qualitatively this non trivial diffusive behaviour. A one loop RG analysis close to the critical dimension d_c=2 confirms that the random force fixed point is unstable and flows towards an uncontrolled strong coupling regime.

cond-mat↗

arXiv2000

Hedging large risks reduces the transaction costs

As soon as one accepts to abandon the zero-risk paradigm of Black-Scholes, very interesting issues concerning risk control arise because different definitions of the risk become unequivalent. Optimal hedges then depend on the quantity one wishes to minimize. We show that a definition of the risk more sensitive to the extreme events generically leads to a decrease both of the probability of extreme losses and of the sensitivity of the hedge on the price of the underlying (the `Gamma'). Therefore, the transaction costs and the impact of hedging on the price dynamics of the underlying are reduced.

cond-mat↗

arXiv2000

Wealth condensation in a simple model of economy

We introduce a simple model of economy, where the time evolution is described by an equation capturing both exchange between individuals and random speculative trading, in such a way that the fundamental symmetry of the economy under an arbitrary change of monetary units is insured. We investigate a mean-field limit of this equation and show that the distribution of wealth is of the Pareto (power-law) type. The Pareto behaviour of the tails of this distribution appears to be robust for finite range models, as shown using both a mapping to the random `directed polymer' problem, as well as numerical simulations. In this context, a transition between an economy dominated by a few individuals from a situation where the wealth is more evenly spread out, is found. An interesting outcome is that the distribution of wealth tends to be very broadly distributed when exchanges are limited, either in amplitude or topologically. Favoring exchanges (and, less surprisingly, increasing taxes) seems to be an efficient way to reduce inequalities.

cond-mat↗

arXiv2000

Multiple scaling regimes in simple aging models

We investigate aging in glassy systems based on a simple model, where a point in configuration space performs thermally activated jumps between the minima of a random energy landscape. The model allows us to show explicitly a subaging behavior and multiple scaling regimes for the correlation function. Both the exponents characterizing the scaling of the different relaxation times with the waiting time and those characterizing the asymptotic decay of the scaling functions are obtained analytically by invoking a `partial equilibrium' concept.

cond-mat.stat-mech↗

arXiv1999

Explaining the Forward Interest Rate Term Structure

We present compelling empirical evidence for a new interpretation of the Forward Rate Curve (FRC) term structure. We find that the average FRC follows a square-root law, with a prefactor related to the spot volatility, suggesting a Value-at-Risk like pricing. We find a striking correlation between the instantaneous FRC and the past spot trend over a certain time horizon. This confirms the idea of an anticipated trend mechanism proposed earlier and provides a natural explanation for the observed shape of the FRC volatility. We find that the one-factor Gaussian Heath-Jarrow-Morton model calibrated to the empirical volatility function fails to adequately describe these features.

cond-mat↗

arXiv1999

Worse fluctuation method for fast Value-at-Risk estimates

We show how one can actually take advantage of the strongly non-Gaussian nature of the fluctuations of financial assets to simplify the calculation of the Value-at-Risk of complex non linear portfolios. The resulting equations are not hard to solve numerically, and should allow fast VaR and $Δ$VaR estimates of large portfolios, where {\it by construction} the influence of rare events is taken into account reliably. Our method can be seen as a correctly probabilized `scenario' calculation (or `stress-testing').

cond-mat↗

arXiv1999

Exact Solutions of a Model for Granular Avalanches

We present exact solutions of the non-linear {\sc bcre} model for granular avalanches without diffusion. We assume a generic sandpile profile consisting of two regions of constant but different slope. Our solution is constructed in terms of characteristic curves from which several novel predictions for experiments on avalanches are deduced: Analytical results are given for the shock condition, shock coordinates, universal quantities at the shock, slope relaxation at large times, velocities of the active region and of the sandpile profile.

cond-mat.stat-mech↗

arXiv1999

An Empirical Investigation of the Forward Interest Rate Term Structure

In this paper we study empirically the Forward Rate Curve (FRC) of 5 different currencies. We confirm and extend the findings of our previous investigation of the U.S. Forward Rate Curve. In particular, the average FRC follows a square-root law, with a prefactor related to the spot volatility, suggesting a Value-at-Risk like pricing. We find a striking correlation between the instantaneous FRC and the past spot trend over a certain time horizon, in agreement with the idea of an extrapolated trend effect. We present a model which can be adequately calibrated to account for these effects.

cond-mat↗

arXiv1999

Apparent multifractality in financial time series

We present a exactly soluble model for financial time series that mimics the long range volatility correlations known to be present in financial data. Although our model is `monofractal' by construction, it shows apparent multiscaling as a result of a slow crossover phenomenon on finite time scales. Our results suggest that it might be hard to distinguish apparent and true multifractal behavior in financial data. Our model also leads to a new family of stable laws for sums of correlated random variables.

cond-mat↗

arXiv1999

Theory of Financial Risk: Basic notions in probability

Risk control has become one of the major concern of financial institutions. The need for adequate statistical tools to measure and anticipate the amplitude of the potential moves of financial markets is clearly expressed, in particular for derivative markets. Classical theories, however, are based on simplified assumptions -- such as Gaussian statistics -- and lead to a systematic (and sometimes dramatic) underestimation of real risks. We summarize a few basic notions in probability theory which are useful in a financial context: Statistics of Extremes, Sums of Random Variables, Central Limit Theorems and Deviations, Correlations and Dependence, and a brief introduction to Random Matrix Theory. This self-contained text corresponds to the first chapter of our book, `Theory of Financial Risk'.

cond-mat↗

arXiv1999

Functional Renormalization Description of the Roughening Transition

We reconsider the problem of the static thermal roughening of an elastic manifold at the critical dimension $d=2$ in a periodic potential, using a perturbative Functional Renormalization Group approach. Our aim is to describe the effective potential seen by the manifold below the roughening temperature on large length scales. We obtain analytically a flow equation for the potential and surface tension of the manifold, valid at all temperatures. On a length scale $L$, the renormalized potential is made up of a succession of quasi parabolic wells, matching onto one another in a singular region of width $\sim L^{-6/5}$ for large $L$. We also obtain numerically the step energy as a function of temperature, and relate our results to the existing experimental data on $^4$He. Finally, we sketch the scenario expected for an arbitrary dimension $d<2$ and examine the case of a non local elasticity which is realized physically for the contact line.

cond-mat↗

arXiv1998

Noise Dressing of Financial Correlation Matrices

We show that results from the theory of random matrices are potentially of great interest to understand the statistical structure of the empirical correlation matrices appearing in the study of price fluctuations. The central result of the present study is the remarkable agreement between the theoretical prediction (based on the assumption that the correlation matrix is random) and empirical data concerning the density of eigenvalues associated to the time series of the different stocks of the S&P500 (or other major markets). In particular the present study raises serious doubts on the blind use of empirical correlation matrices for risk management.

cond-mat↗

arXiv1998

Comment on ``Roughening Transition of Interfaces in Disordered Media''

Emig and Nattermann (Phys. Rev. Lett. 81, 1469 (1998)) have recently investigated the competition between lattice pinning and impurity pinning using a Renormalisation Group (RG) approach. For elastic objects of internal dimensions $2 < D < 4$, they find, at zero temperature, an interesting second order phase transition between a flat phase for small disorder and a rough phase for large disorder. These results contrast with those obtained using the replica variational approach for the same problem, where a first order transition between flat and rough phases was predicted. In this comment, we show that these results can be reconciled by analysing the RG flow for an arbitrary dimension $N$ for the displacement field.

cond-mat↗

arXiv1998

Back to basics: historical option pricing revisited

We reconsider the problem of option pricing using historical probability distributions. We first discuss how the risk-minimisation scheme proposed recently is an adequate starting point under the realistic assumption that price increments are uncorrelated (but not necessarily independent) and of arbitrary probability density. We discuss in particular how, in the Gaussian limit, the Black-Scholes results are recovered, including the fact that the average return of the underlying stock disappears from the price (and the hedging strategy). We compare this theory to real option prices and find these reflect in a surprisingly accurate way the subtle statistical features of the underlying asset fluctuations.

cond-mat↗

arXiv1998

Elements for a Theory of Financial Risks

Estimating and controlling large risks has become one of the main concern of financial institutions. This requires the development of adequate statistical models and theoretical tools (which go beyond the traditionnal theories based on Gaussian statistics), and their practical implementation. Here we describe three interrelated aspects of this program: we first give a brief survey of the peculiar statistical properties of the empirical price fluctuations. We then review how an option pricing theory consistent with these statistical features can be constructed, and compared with real market prices for options. We finally argue that a true `microscopic' theory of price fluctuations (rather than a statistical model) would be most valuable for risk assessment. A simple Langevin-like equation is proposed, as a possible step in this direction.

cond-mat↗

arXiv1998

Are Financial Crashes Predictable?

We critically review recent claims that financial crashes can be predicted using the idea of log-periodic oscillations or by other methods inspired by the physics of critical phenomena. In particular, the October 1997 `correction' does not appear to be the accumulation point of a geometric series of local minima.

cond-mat.stat-mech↗