Information and option pricings

X. Guo

Quantitative Finance, 2001, vol. 1, issue 1, 38-44

Abstract: How can one relate stock fluctuations and information-based human activities? We present a model of an incomplete market by adjoining the Black-Scholes exponential Brownian motion model for stock fluctuations with a hidden Markov process, which represents the state of information in the investors' community. The drift and volatility parameters take different values depending on the state of this hidden Markov process. Standard option pricing procedure under this model becomes problematic. Yet, with an additional economic assumption, we provide an explicit closed-form formula for the arbitrage-free price of the European call option. Our model can be discretized via a Skorohod embedding technique. We conclude with an example of a simulation of IBM stock, which shows that, not surprisingly, information does affect the market.

Date: 2001
References: Add references at CitEc
Citations: View citations in EconPapers (70)

Downloads: (external link)
http://www.tandfonline.com/doi/abs/10.1080/713665550 (text/html)
Access to full text is restricted to subscribers.

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:taf:quantf:v:1:y:2001:i:1:p:38-44

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/RQUF20

DOI: 10.1080/713665550

Access Statistics for this article

Quantitative Finance is currently edited by Michael Dempster and Jim Gatheral

More articles in Quantitative Finance from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().