Modern Pricing Models - Coursework Example

Financial analysts and money experts are increasingly using different types of modern pricing models such as the Merton Model, Heston Model, and Bates Model to help in the modeling and simulation of financial markets in order to determine the correct price options(risk). According to many experts, the models provide an important tool for quantifying the risks and estimating a company's expected returns. The geometric Brownian motion(GBM) is one of the major building blocks of the modern financial market analysis.

Wt, Wt refers to wiener processes or random walks. As such, one may require a piece wise-constants tatus in the parameters for him or her to be able to retain the tractability of the model. Another process of exploring the volatility surface is to add a second process of variance in the whole equation, which is very independent of the first equation (Rouah2013). 22Financial analysts and money experts are increasingly using different types of modern pricing models such as the Merton Model, Heston Model, and Bates Model to help in the modeling and simulation of financial markets in order to determine the correct price options(risk).

According to many experts, the models provide an important tool for quantifying the risks and estimating a company's expected returns. The geometric Brownian motion(GBM) is one of the major building blocks of the modern financial market analysis. The Geometric Brownian motion (GBM) generally acts as the foundation for most of the models used in modern finance. It is the building block of most concepts applied by stock pricing models. This is the case particularly in the Black-Scholes model where the basic price of the stock is assumed to follow the basic dynamics of GBM as:However, the model assumptions have not been confirmed with empirical facts.

For example, the financial returns generally show fatter tails that are than those postulated by the Black-Scholes model in the effort to predict how volatile the stocks in the market.