Analytically pricing European options in dynamic markets: Incorporating liquidity variations and economic cycles

Xin-Jiang He, Puneet Pasricha and Sha Lin

Economic Modelling, 2024, vol. 139, issue C

Abstract: This paper discusses the European option pricing problem in the context of asset prices being influenced by liquidity risks and economic cycles. We employ regime switching for asset volatility, and liquidity risks are captured by market-wide liquidity. We obtain an analytical formulation of European option prices, allowing for fast model calibration using real-market data. By estimating model parameters using real option data, we show that pricing errors can be significantly reduced using our model that considers stochastic liquidity, indicating that our model has real-world applications. Our results can help investors and regulators better understand the market and provide a potentially effective risk management tool.

Keywords: Liquidity risks; Regime switching; European options; Characteristic function; Closed form (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2024
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0264999324001962
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:139:y:2024:i:c:s0264999324001962

DOI: 10.1016/j.econmod.2024.106839

Access Statistics for this article

Economic Modelling is currently edited by S. Hall and P. Pauly

More articles in Economic Modelling from Elsevier
Bibliographic data for series maintained by Catherine Liu ().