Our derivation of the distribution function for future returns is based on the risk neutral approach which gives a functional dependence for the European call (put) option price, C(K), given the strike price, K, and the distribution function of the returns. We derive this distribution function using for C(K) a Black-Scholes (BS) expression with volatility, σ, in the form of a volatility smile. We show that this approach based on a volatility smile leads to relative minima for the distribution function ("bad" probabilities) never observed in real data and, in the worst cases, negative probabilities. We show that these undesirable effects can be eliminated by requiring "adiabatic" conditions on the volatility smile.
This work presents a theoretical and empirical evaluation of Anderson-Darling test when the sample size is limited. The test can be applied in order to backtest the risk factors dynamics in the context of Counterparty Credit Risk modelling. We show the limits of such test when backtesting the distributions of an interest rate model over long time horizons and we propose a modified version of the test that is able to detect more efficiently an underestimation of the model's volatility. Finally we provide an empirical application. JEL: C19. C22
Topological phase space disconnection has been recently found to be a general phenomenon in many-body spin system with anisotropic interaction. We show that the power law divergence of magnetic reversal time at the energy signaling such disconnection is generic for long-range interacting systems with an exponent proportional to the number of particles. We also study the modifications induced putting the system in contact with a thermal bath. Using the canonical formalism we analyze the magnetic reversal times at any temperature. Moreover, due to the divergence of reversal time at the energy disconnection threshold we can recover, using saddle point approximation, a simple exponential dependence on the inverse temperature showing the explicit relevance of the energy disconnection threshold for finite many-body interacting systems at finite temperature. This sets a general framework to understand the emergence of ferromagnetism in finite magnetic systems starting from microscopic models without phenomenological on-site barriers.
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