On Valuing European Option: VAR-COVAR Approach
Ahmad M. Talafha and
Journal of Finance and Investment Analysis, 2017, vol. 6, issue 3, 1
Black and Scholes (B-S) in 1973 introduced the famous B-S formulaÂ for pricing a European-style stock option. The B-S formula dependsÂ on some assumptions that are too restrictive and cannot be entirelyÂ met. This paper relaxes some of the assumptions underpinning the BSÂ model by deriving the equity price process within the framework ofÂ a vector autoregressive (VAR) model using stock market indices. TheÂ constant risk-free interest rate is replaced by a cointegrated VAR (COVAR)Â model using Treasury securities. Value of a European call optionÂ via Monte Carlo simulation is provided. We used antithetic and controlÂ variates as variance reduction techniques to improve upon the accuracyÂ of our simulation.Mathematics Subject Classification: G12; C15; G22Keywords: Option pricing; Vector Autoregressive; Cointegrated Vector Autoregressive;Â Monte Carlo; Antithetic Variates; Control Variates
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Persistent link: https://EconPapers.repec.org/RePEc:spt:fininv:v:6:y:2017:i:3:f:6_3_1
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