37211 - Probability Models for Finance 2

Course contents

1. Stochastic calculus principles: stochastic process, discrete and continuous martingale, diffusion and Ito's process, Markov 's process, exponential martingale and probability changing, Girsanov's theorem, stochastic integration and Ito's lemma, SDE and PDE, Kolmogorov's PDE, Feynman-Kac's theorem;
2. Plain vanilla contingent claims's pricing and hedging: forward and future, european and american options, pricing and hedging by arbitrage, self-financing portfolio, CRR's model, BS's model, volatility analysis and smile effect, arbitrage model for Ito's market, market premium and market numeraire, BS formula for exchange options, complete and incomplete markets;
3. Domestic-Foreign arbitrage and exotic options: Black's model, quantos and compos, digital options, regular and reverse barrier options, loockback options and options on running minimum (maximum) of underlying asset;
4. Term structure of interest rate and interest rate-contingent claims: structural equations of interest rates (HJM and Musiela), stationary and non-stationary Vasicek's model, multidimensional Vasicek's model, CIR's model, pricing and hedging of interest rate's derivatives (zcb with random interest rate, options on zcb, swap, cap and floor, swaption ).

Readings/Bibliography

• Financial calculus-An introduction to derivative pricing, Baxter-Rennie, Cambridge university press, 1997;
• Elementary stochastic calculus with finance in view, Mikosch, World scientific, Singapore 1999;
• Introduction to stochastic calculus applied to finance, Lamberton-Lapeyre, Chapman and Hall, London 1996.
  

Teaching methods

Theoretical lessons will be support by applied examples of discussed models to incite students to find them-self the explicit solutions of the theoretical problem presented by applying the correct mathematical instruments.

Assessment methods

Obligatory written exam: 3 exercices to solve in 90 minuts.

Optional oral exam: oral exam about all the programme of the course.

Office hours

See the website of Silvia Romagnoli