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                          Seminar

Title     : Subordinate diffusions: applications in financial modeling and option pricing

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Abstract:
Many popular financial models are constructed based on diffusions. However empirical evidence suggests that in many cases jumps exist and could be state-dependent, making diffusion-based models inappropriate. By time changing diffusions with Levy subordinators, we obtain a class of tractable jump-diffusions and pure jump processes with state-dependent jumps, which we term as subordinate diffusions. As an application, we develop a new class of commodity derivative models based on subordinate Ornstein-Uhlenbeck processes. The resulting models are consistent with the initial futures curve, exhibit mean-reverting jumps and Samuelson’s maturity effect, and are flexible enough to capture a variety of implied volatility smile patterns observed in commodities futures options. We derive solutions to European and Bermudan options by eigenfunction expansions and American option prices can be efficiently computed as the Bermudan limit via extrapolation.

Biography:
Lingfei Li received his B.S. in Applied Mathematics from Peking University, China in 2007, and his M.S. and Ph.D. in Industrial Engineering and Management Sciences from Northwestern University, USA in 2008 and 2012. Currently he is an Assistant Professor in the Department of Systems Engineering and Engineering Management, the Chinese University of Hong Kong. His research interests include financial engineering and applied probability.

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