Option Pricing Based on Alternative Jump Size Distributions

Jian Chen () and Chenghu Ma ()
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Jian Chen: School of Economics, Xiamen University, Xiamen 361005, China
Chenghu Ma: School of Management, Fudan University, Shanghai 200433, China

Frontiers of Economics in China-Selected Publications from Chinese Universities, 2016, vol. 11, issue 3, 439-467

Abstract: It is well known that volatility smirks and heavy-tailed asset return distributions are two violations of the Black-Scholes model. This paper investigates the role of jump size distribution played in explaining these two abnormalities. We consider a jump-diffusion model with Laplace jump size distribution, in comparison to the conventional normal distribution. In addition, our analysis is built upon a pure exchange economy, in which the representative agent¡¯s risk preference shows a fanning characteristic. We find that, when a fanning effect is present, Laplace model produces a more remarkable leptokurtic pattern of the risk-neutral distribution implied by options, as well as generating more pronounced volatility smirks than the normal model.

Keywords: general equilibrium; recursive utility; option pricing; Laplace distribution; volatility smirk (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (1)

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