Pierre Henry-Labordère, a member of the global markets quantitative analytics team at Societe Generale Corporate & Investment Banking, and Hamza Guennoun, a senior quantitative researcher within the same team, dialled in from Paris to talk about their new paper, Equity modelling with local stochastic volatility and stochastic discrete dividends.
The quants explained the mechanics of the physics technique they use in the paper, called the particle method, to calibrate exotic options with both equity and dividend underlyings, such as knockout dividend swaps, in the presence of stochastic dividends.
The quants said pricing of these products have been challenging until now because dividends would have to be modelled stochastically and this would lead to a slightly inaccurate calibration.
Fixing this problem by calibrating the model in a more accurate way can make it easier to risk-manage products with stochastic dividends, said SG CIB’s Guennoun.
“Exotics on both equities and dividends are not very liquid, but this is partly due to the fact that traders don’t have the tools to risk-manage the products,” Guennoun said. “This model can increase the liquidity of such products. It will allow the trader to handle at the same time, in a flexible way, the joint density of the equity underlying and also dividends.”
The quants also spoke about their future research projects, which over the next couple of years will focus mainly on the application of deep learning techniques to the calibration of multi-dimensional local stochastic volatility models.
“We are also trying to speed up the pricing of exotics. This is actually a crucial issue for the business. This will allow clients to have access to the price very quickly and to play with the payoff parameters and with several underlyings. To do that one idea would be to learn the pricing formula using neural networks,” said Guennoun.
One example of this would be autocallables, which are typically written as the worst of three stock underlyings. Having a faster pricing method would, therefore, allow clients to tweak the parameters and observe the prices very quickly.
1:20 Knockout dividend swaps
2:33 Applications of knockout dividend swaps
4:03 Issues with the calibration of models with stochastic dividends
5:26 The particle method
7:01 The particle method in exotics pricing
8:56 Discrete dividends
11:07 Future projects
12:45 Autocallable pricing
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