MSc Thesis Defense - Yuyang Cheng (No Public Lecture)

Title: Generalized 4/2 Factor Model

Abstract: We investigate portfolio optimization, risk management, and derivative pricing for a factor stochastic model that considers the 4/2 stochastic volatility on the common/systematic factor as well as on the intrinsic factor. This setting allows us to capture stochastic volatility and stochastic covariation among assets. The model is also a generalization of existing models in the literature as it includes the mean reverting property and spillover effect to capture wider types of financial assets. At a theoretical level we identify conditions for well-defined changes of measure. A quasi-closed form solution within a 4/2 structured model is obtained for a portfolio optimization problem. In the numerical section, a sensitivity analysis reveals a substantial impact on the implied volatility surface and risk measures level due to small changes in the 3/2 component b. In addition, commonality loading, spillover effect, and dependency among common factors are also influential with regards to implied volatility and risk measures.