Our Research Led On To Other Things, Such As The Fact That Exchange Rates Are Not Lognormally Distributed. - SearchQuotes

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Our research led on to other things, such as the fact that exchange rates are not lognormally distributed.

John Hull

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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.

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In the interest rate area, traders have for a long time used a version of what is known as Black's model for European bond options; another version of the same model for caps and floors; and yet another version of the same model for European swap options.

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If each of your time steps is one week long, you are not modeling the stock price terribly well over a one-week time period, because you are saying that there are only two possible outcomes.

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I didn't become interested in derivatives until 1982, 1983.

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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.

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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.

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