Identifying Stock Market Bubbles: Modeling Illiquidity Premium and Bid-Ask Prices of Financial Securities
by Azar Karimov (Author)

About the Author
Dr. Azar Karimov, CFA, FRM is a graduate in Financial Mathematics from the Institute of Applied Mathematics at Middle East Technical University. He has worked as a risk manager in intergovernmental diplomatic organization, Turkish private banking institutions and accumulated an extensive industry experience in liquidity management, financial risk management, stress testing, and asset-liability management. He has also delivered on-the- job trainings on advanced financial risk modelling at Turkish regulatory authorities.

About this book
This book introduces readers to a new approach to identifying stock market bubbles by using the illiquidity premium, a parameter derived by employing conic finance theory. Further, it shows how to develop the closed form formulas of the bid and ask prices of European options by using Black-Scholes and Kou models. By using the derived formulas and sliding windows technique, the book explains how to numerically calculate illiquidity premiums. The methods introduced here will enable readers interested in risk management, portfolio optimization and hedging in real-time to identify when asset prices are in a bubble state and when that bubble bursts. Moreover, the techniques discussed will allow them to accurately recognize periods of exuberance and panic, and to measure how different strategies work during these phases with respect to calmer periods of market behavior. A brief history of financial bubbles and an outlook on future developments serve to round out the coverage.

Table of contents
1 Introduction
    Reference
2 Review on Research Conducted
    2.1 Inventory Models
        2.2 Information Models
        2.2.1 Informed Traders vs. Market Makers
        2.2.2 Bid-Ask Spread as the Statistical Model
        2.2.3 Introduction of Transaction Costs
    2.3 Conic Finance
    References
3 Theory of Conic Finance
    3.1 Conic Finance
    3.2 Conic Finance in Practice
    3.3 Distortion Functions
        3.3.1 Minvar
        3.3.2 Maxvar
        3.3.3 Maxminvar
        3.3.4 Minmaxvar
        3.3.5 Wang Transform
    References
4 Stock Prices Follow a Brownian Motion
    4.1 Geometric Brownian Motion: Introduction
    4.2 Option Pricing with Geometric Brownian Motion
    4.3 Bid-Ask Prices of European Options Under Brownian Motion
    4.4 Data and Numerical Application
    References
5 Stock Prices Follow a Double Exponential Jump-Diffusion Model
    5.1 Details of Jump-Diffusion Models
        5.1.1 Reasons for Using Jump-Diffusion Models
        5.1.2 Leptokurticity of Returns
        5.1.3 Exponential and Power-Type Tails
        5.1.4 Implied Volatility Smile
        5.1.5 Alternatives for Black-Scholes Model
        5.1.6 Unique Characteristics of Jump Diffusion
    5.2 Jump-Diffusion Model
    5.3 Distribution Function of Jump Process
    5.4 Distribution Function of Lt
    5.5 Risk-Neutral Dynamics
    References
6 Numerical Implementation and Parameter Estimation Under KOU Model
    6.1 Estimation Method: Theoretical Background
        6.1.1 Maximum-Likelihood Estimation
        6.1.2 Generalized Method of Moments
        6.1.3 Characteristic Function Estimation Method
        6.1.4 Monte-Carlo Simulation
    6.2 Estimation Methods: Numerical Application
        6.2.1 Characteristic Function and Moments of Kou Model
        6.2.2 Simulation of Kou Model
        6.2.3 Cumulant Matching Method
        6.2.4 Maximum-Likelihood Estimation
        6.2.5 Method of Characteristic Function Estimation
    6.3 Bid-Ask Prices of European Options Under Kou Model
    6.4 Data and Numerical Application of the Estimation Results of Kou Model
    References
7 Illiquidity Premium and Connection with Financial Bubbles
    7.1 A Brief History of Financial Bubbles
        7.1.1 Tulip Mania
        7.1.2 South-Sea Bubble
        7.1.3 1929 Great Depression
        7.1.4 The Tech Bubble
        7.1.5 Subprime Mortgage Bubble
    7.2 Illiquidity Premium vs. Financial Bubbles
    7.3 Comparison with Other Bubble-Detection Techniques
        7.3.1 Value in Economics
        7.3.2 Rational Bubbles
        7.3.3 Heterogeneous Beliefs Bubbles
        7.3.4 Behavioral Bubbles
    7.4 Log-Periodic Power Law Model vs. Illiquidity Premium
    7.5 Investment Management and Illiquidity Premium
    References
8 Conclusion and Future Outlook
Appendix A Some Distributions Under Wang Transform
Appendix B Deriving Bid and Ask Prices for Options Under Brownian Motion Assumptions
    B.1 Prices of a European Call Options
        B.1.1 Bid Price
        B.1.2 Ask Price
    B.2 Prices of a European Put Options
        B.2.1 Bid Price
        B.2.2 Ask Price

Series: Contributions to Management Science
Length: 131 pages
Publisher: Springer; 1st ed. 2017 edition (September 30, 2017)
Language: English
ISBN-10: 3319650084
ISBN-13: 978-3319650081