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Option pricing and managing equity linked insurance (ELI) require the proper modeling of stock return dynamics. Due to the long duration nature of equity-linked insurance products, a stock return model must be able to deal simultaneously with the preceding stylized facts and the impact of market structure changes. In response, this article proposes stock return dynamics that combine Lévy processes in a regime-switching framework. We focus on a non-Gaussian, generalized hyperbolic distribution. We use the most popular linked equity of ELIs, the S&P 500 index, as an example. The empirical study verifies that the proposed regime-switching generalized hyperbolic (RSGH) model gives the best fit to data. In investigating the effects of stock return modeling on pricing and risk management for financial contracts, we derive the characteristic function, embedded option price, and risk measure of equity-linked insurance analytically. More importantly, we demonstrate that the regime-switching generalized hyperbolic (RSGH) model is realistic and can meet the stylistic facts of stock returns, which in turn can be employed in option pricing and risk management decisions. [ABSTRACT FROM AUTHOR]

This article presents a closed-form formula for calculating the loan-to-value (LTV) ratio in an adjusted-rate reverse mortgage (RM) with a lump sum payment. Previous literatures consider the pricing of RM in a constant interest rate assumption and price it on fixed-rate loans. This paper successfully considers the dynamic of interest rate and the adjustable-rate RM simultaneously. This paper also considers the housing price shock into the valuation model. Assuming that house prices follow a jump diffusion process with a stochastic interest rate and that the loan interest rate is adjusted instantaneously according to the short rate, we demonstrate that the LTV ratio is independent of the term structure of interest rates. This argument holds even when housing prices follow a general process: an exponential Lévy process. In addition, the HECM (Home Equity Conversion Mortgage) program may be not sustainable, especially for a higher level of housing price volatility. Finally, when the loan interest rate is adjusted periodically according to the LIBOR rate, our finding reveals that the LTV ratio is insensitive to the parameters characterizing the CIR model. [ABSTRACT FROM AUTHOR]

Under a no-arbitrage assumption, the futures price converges to the spot price at the maturity of the futures contract, where the basis equals zero. Assuming that the basis process follows a modified Brownian bridge process with a zero basis at maturity, we derive the closed-form solutions of futures and futures options with the basis risk under the stochastic interest rate. We make a comparison of the Black model under a stochastic interest rate and our model in an empirical test using the daily data of S&P 500 futures call options. The overall mean errors in terms of index points and percentage are -4.771 and -27.83%, respectively, for the Black model and 0.757 and 1.30%, respectively, for our model. This evidence supports the occurrence of basis risk in S&P 500 futures call options. [ABSTRACT FROM AUTHOR]

With the intersection of market and credit risk, the first contribution is to derive the analytic formulas of the Credit Linked Notes (CLNs) and the leveraged total return CLNs issued by an Special Purpose Vehicle (SPV) or the protection buyer. The second contribution is to prove that the values of structured CLNs issued by an SPV are higher than the ones issued by the protection buyer. When the credit quality of the reference obligation and protection buyer becomes worse or the leverage effect is higher, it is a superior solution for the structured CLNs issued through an SPV. Third, the empirical results of credit spreads do not incorporate the correlation coefficient of spot rate and market index into their regression models and show that they are positively correlated with the volatilities of spot rate and return on market index; however, we find that the relationship among them depends on the sign of correlation coefficient of spot rate and equity index market. Finally, using the differences in the maturities of the note and the reference obligation as the proxy for basis risk measure, we demonstrate that the purpose of the SPV is not used to eliminate the basis risk but the credit risk of protection buyer. [ABSTRACT FROM AUTHOR]

This study empirically tests the performance of the Future Option model with Basis Risk (FOBR) proposed by Wang et al. (2005). The Black (1976) model is used as the competing model in this empirical test. The basis risk is the only difference between the two competing models and is therefore used to determine the existence of basis risk. The FOBR model is empirically tested using the daily data of S&P 500 call options on futures. The model outperforms Black's model due to its better prediction power. For the total sample data, the mean errors in terms of index and percentages are 0.973 and 1.0% for the FOBR model, and they are -4.468 and -27.1% for Black's model. The empirical test also supports the occurrence of basis risk in futures options on stock index by eliminating systematic moneyness and time-to-maturity biases produced by Black's model. [ABSTRACT FROM AUTHOR]

The article makes two contributions to the literature. The first contribution is to derive a closed-form solution of Taiwanese capped options. We also provide the properties of Taiwanese capped options and the phenomenon of delta jump at monitoring dates. When the interest rate changes dramatically, instead of deriving the pricing formulas for derivatives separately, the second contribution is to provide the closed-form solution of generalized capped exchange options with stochastic barriers under the Hull and White framework. Special cases of generalized capped exchange options with stochastic barriers are abundant. They include capped (floored) options, capped (floored) options with exponential barriers, capped (floored) options with related assets or indices as triggers and capped (floored) options with related assets or indices as triggers and other related assets as barriers. [ABSTRACT FROM AUTHOR]

Assuming that a futures price is a function of the underlying asset and the basis, and that a Brownian bridge process drives the basis, this article provides the closed-form solution of futures with basis risk (FBR). The Brownian bridge process ensures that the basis is zero at the maturity of a futures contract. The FBR model is empirically tested with daily S&P500 futures data and is found to outperform both the Cornell and French (CF, 1983a) and Yan (2002) models. The overall mean errors in terms of index points and percentages are 0.1918 and -0.002% for the FBR model, compared to -1.8806 and -0.2088% for the CF model, and 2.5072 and 0.0973% for the Yan model. [ABSTRACT FROM AUTHOR]