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Rong, Ning

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  • Paper Title: Pricing of RCLA contract in incomplete market- PIDE approach
  • Department Affiliation: Economics
  • Supervisors’ Names: Professor Geoffrey Kingston

Purpose:

The purpose of this project is to implement the finite difference method into the pricing of the equity-linked insurance product in the incomplete market. Besides the Brownian motion, I included two extra risk terms, namely jumps and stochastic volatilities. Accordingly, the general two dimensional finite difference method for solving pricing PDE is extended to three-dimensions, and extra integral component is added to capture the possible jump in the process of risky asset.

Originality:

It is the first study to use the three dimensional PIDE as the tool for pricing RCLA contract in the incomplete market.

Key literature/theoretical perspective:

Huang, Milevsky and Salisbury (2009), Heston (1993), Cont and Tankov (2004), Tankov and Voltchkova (2006).

Design/methodology/approach:

By introducing the concept of RCLA contact, then I derive the risky asset process in the equivalent martingale measure, and further compute the corresponding PIDE in the Matlab.

Findings:

By expanding the number of sources of risks in the asset process which will lead to more accuracy price of RCLA contract.

Research limitations/implications:

The limitation is that using PIDE may sometimes lead to convergence problem.

Practical and Social implications: 

Providing the guidance to insurance companies or investment banks that are looking for the general pricing formula for the equity-linked securities.

Keywords:

RCLA, Equivalent Martingale Measure, Stochastic Volatility, Jump, PIDE