A Nonparametric Option Pricing Model Using Higher Moments

Peter Julian Cayton and Kin-Yip Ho

MPRA Paper from University Library of Munich, Germany

Abstract: A nonparametric model that includes non-Gaussian characteristics of skewness and kurtosis is proposed based on the cubic market capital asset pricing model. It is an equilibrium pricing model but risk-neutral valuation can be introduced through return data transformation. The model complies with the put-call parity principle of option pricing theory. The properties of the model are studied through simulation methods and compared with the Black-Scholes model. Simulation scenarios include cases on nonnormality in skewness and kurtosis, nonconstant variance, moneyness, contract duration, and interest rate levels. The proposed model can have negative prices in cases of out-of-money options and in simulation cases that are different from real-market situations, but the frequency of negative prices is reduced when risk-neutral valuation is implemented. The model is more adaptive and more conservative in pricing options compared to the Black-Scholes model when nonnormalities exist in the returns data.

Keywords: Capital Asset Pricing Model; Call Options; Kurtosis; Skewness (search for similar items in EconPapers)
JEL-codes: C14 C51 C58 G12 G13 G23 (search for similar items in EconPapers)
Date: 2015-04
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Working Paper: A Nonparametric Option Pricing Model Using Higher Moments (2015)
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