Equities

Abstract

This chapter deals with derivatives that depend on the value of one or several equity stocks or equity indices. We argue that equity stocks are similar to the idealized underlying S that has been considered in previous chapters and it is therefore possible to use the models discussed there. There are, however, certain aspects of the equity stock behavior that do not agree with the idealized underlying. One example is that a company can default, which results in a worthless stock. The theory treating such credit defaults is a quantitative area of its own. Some of the methods used in that field are similar to the ones in this book, e.g. hazard-rate models for defaults corresponds to short-rate models for interest rates, but most often they are fundamentally different. Derivatives that depend on credit defaults often rely on copula models and on models for extreme events. This makes credit default modeling closely linked to auctorial mathematics and we have therefore chosen not to include this area in the set of the major asset classes discussed in this book.