 Pricing options on scenario treesNikolas Topaloglou, Hercules Vladimirou and Stavros Zenios Journal of Banking & Finance, 2008, vol. 32, issue 2, 283-298 Abstract: We examine valuation procedures that can be applied to incorporate options in scenario-based portfolio optimization models. Stochastic programming models use discrete scenarios to represent the stochastic evolution of asset prices. At issue is the adoption of suitable procedures to price options on the basis of the postulated discrete distributions of asset prices so as to ensure internally consistent portfolio optimization models. We adapt and implement two methods to price European options in accordance with discrete distributions represented by scenario trees and assess their performance with numerical tests. We consider features of option prices that are observed in practice. We find that asymmetries and/or leptokurtic features in the distribution of the underlying materially affect option prices; we quantify the impact of higher moments (skewness and excess kurtosis) on option prices. We demonstrate through empirical tests using market prices of the S&P500 stock index and options on the index that the proposed procedures consistently approximate the observed prices of options under different market regimes, especially for deep out-of-the-money options. Date: 2008 Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:32:y:2008:i:2:p:283-298 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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