Equilibrium approach of asset and option pricing under Lévy process and stochastic volatility

Shuang Li, Yanli Zhou, Yonghong Wu and Xiangyu Ge
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Shuang Li: Department of Mathematics and Statistics, Curtin University, Australia
Yanli Zhou: School of Finance, Zhongnan University of Economics and Law, China
Yonghong Wu: Department of Mathematics and Statistics, Curtin University, Australia; School of Statistics and Mathematics, Zhongnan University of Economics and Law, China
Xiangyu Ge: School of Statistics and Mathematics, Zhongnan University of Economics and Law, China

Australian Journal of Management, 2017, vol. 42, issue 2, 276-295

Abstract: This paper studies the equity premium and option pricing under the general equilibrium framework taking into account stochastic volatility. We establish analytical expressions for the equity premium and pricing kernel of the stock process. Moreover, the equilibrium option pricing formula is derived by the Fourier transformation method. Numerical results show that our model is superior to the previous model with constant volatility in explaining some financial phenomena, such as negative variance risk premium, implied volatilities and negative skewness risk premium. As the price of the underlying asset is modeled as the exponential of the Lévy process with stochastic volatility, our model is more general than the existing equilibrium pricing models.

Keywords: Equity premium; equilibrium framework; Lévy process; option pricing; stochastic volatility (search for similar items in EconPapers)
JEL-codes: C62 C63 G12 G13 (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:sae:ausman:v:42:y:2017:i:2:p:276-295

DOI: 10.1177/0312896215619966

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