John Hull
John Hull
concerned conclusion far huge pricing volatility
Briefly speaking, our conclusion is that stochastic volatility does not make a huge difference as far as the pricing is concerned if you get the average volatility right. It makes a big difference as far as hedging is concerned.
average interest low rates
When interest rates are high you want the average direction in which interest rates are moving to be downward; when interest rates are low you want the average direction to be upward.
I didn't become interested in derivatives until 1982, 1983.
concerns extreme issue likely measures mentioned using
One important measurement issue concerns the fat tails problem that I mentioned earlier. VAR is concerned with extreme outcomes. If the tails of the probability distributions we are using are too thin, our VAR measures are likely to be too low.
cannot concluded delta people rely simplistic sort sounds
We concluded that you cannot rely on delta hedging alone. It sounds simplistic to say that now, but back then, this was the sort of thing people were only just beginning to realize.
interest rates sort term type
The problem with interest rates are that you are not modeling a single number, you are modeling a whole term structure, so it is a sort of different type of problem.
challenge depended interest model rates value
The real challenge was to model all the interest rates simultaneously, so you could value something that depended not only on the three-month interest rate, but on other interest rates as well.
branches center extreme parts pattern reached reflect shape zero
Yes, our tree has an interesting shape. The center branches reflect the shape of the zero curve. When extreme parts of the tree are reached the branching pattern changes to accommodate the mean reversion.
known nonlinear terms
There are challenges in terms of the measurement of VAR for what are known as nonlinear derivatives, where things like gamma and vega are important dimensions of the risk.
since stimulated
We started giving presentations at practitioner conferences in 1986, and since then all of our derivatives research has been stimulated by contact with practitioners.
trying
Our starting point then was trying to find a way to incorporate mean reversion into the HoLee model.
alan asset developed known model moves next price spent underlying volatility
Alan White and I spent the next two or three years working together on this. We developed what is known a stochastic volatility model. This is a model where the volatility as well as the underlying asset price moves around in an unpredictable way.
I think VAR is a very healthy development within the industry.
average depends interest level moves rate
Our tree is actually a tree of the short-term interest rate. The average direction in which the short-term interest rate moves depends on the level of the rate. When the rate is very high, that direction is downward; when the rate is very low, it is upward.