In this paper we describe a copula based lattice method to value asset and interest rate derivative instruments. The method exploits the copula-marginals decomposition of a Lévy process to separate out the contribution of time dependency and of distributions at future times. This enables the lattice to fit to volatility smiles at futures times. The method is benchmarked against European call and discrete barrier options. We go on to value European and Bermudan derivatives with a variety of time dependence structures and marginal distributions. We find that the method benchmarks well, and that it is easy to use for general processes.
A copula lattice based method for asset returns
MARENA, Marina;
2005-01-01
Abstract
In this paper we describe a copula based lattice method to value asset and interest rate derivative instruments. The method exploits the copula-marginals decomposition of a Lévy process to separate out the contribution of time dependency and of distributions at future times. This enables the lattice to fit to volatility smiles at futures times. The method is benchmarked against European call and discrete barrier options. We go on to value European and Bermudan derivatives with a variety of time dependence structures and marginal distributions. We find that the method benchmarks well, and that it is easy to use for general processes.
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