ABSTRACT The model of Bates specifies a rich, flexible structure of stock dynamics suitable for applications in finance and economics, including valuation of derivative securities. This paper analytically derives a closed-form expression for the joint conditional characteristic function of a stock’s log-price and squared volatility under the model dynamics. The use of the function, based on inverting it, is illustrated on examples of pricing European-, Bermudan-, and American- options. The discussed approach for European- derivatives improves on the option formula of Bates. The suggested approach for American- derivatives, based on a compound-option technique, offers an alternative solution to existing finite-difference methods.
Cite this paper
O. Zhylyevskyy, "Joint Characteristic Function of Stock Log-Price and Squared Volatility in the Bates Model and Its Asset Pricing Applications," Theoretical Economics Letters, Vol. 2 No. 4, 2012, pp. 400-407. doi: 10.4236/tel.2012.24074.
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