In:
International Journal of Theoretical and Applied Finance, World Scientific Pub Co Pte Ltd, Vol. 22, No. 07 ( 2019-11), p. 1950041-
Abstract:
A growing body of literature suggests that heavy tailed distributions represent an adequate model for the observations of log returns of stocks. Motivated by these findings, here, we develop a discrete time framework for pricing of European options. Probability density functions of log returns for different periods are conveniently taken to be convolutions of the Student’s [Formula: see text]-distribution with three degrees of freedom. The supports of these distributions are truncated in order to obtain finite values for the options. Within this framework, options with different strikes and maturities for one stock rely on a single parameter — the standard deviation of the Student’s [Formula: see text] -distribution for unit period. We provide a study which shows that the distribution support width has weak influence on the option prices for certain range of values of the width. It is furthermore shown that such family of truncated distributions approximately satisfies the no-arbitrage principle and the put-call parity. The relevance of the pricing procedure is empirically verified by obtaining remarkably good match of the numerically computed values by our scheme to real market data.
Type of Medium:
Online Resource
ISSN:
0219-0249
,
1793-6322
DOI:
10.1142/S0219024919500419
Language:
English
Publisher:
World Scientific Pub Co Pte Ltd
Publication Date:
2019
SSG:
3,2
