Financial Markets as Adaptive Ecosystems
Capital Fund Management - Department of Science and Finance
Imperial College London; CNRS - Universite de Paris VI
Centre d'Etudes de Saclay (CEA) - Service de Physique de l'Etat Condense (SPEC); Capital Fund Management - Department of Science and Finance
September 18, 1996
Options markets offer an interesting example of the adaptation of a population to a complex environment, through trial and error and by 'natural' selection. Guided by the Black-Scholes theory but constrained by the fact that mispricing leads to arbitrage opportunities, options markets agree on prices which are close but significantly and systematically different from those given by the Black- Scholes formula. We re-examine the informational content of option prices in the light of the notion of implied kurtosis, analogous to that of implied volatility but taking into account the non-Gaussian character of the fluctuations of the underlying asset. We conclude by a detailed empirical study of market prices for options on German Bund futures, showing very good agreement between implied kurtosis calculated from option prices and empirical kurtosis calculated using prices of the underlying asset. Our results show that the market has adapted itself to incorporate more information on the statistical properties of returns than that conveyed by the Black-Scholes model.
JEL Classification: G10, G13working papers series
Date posted: October 17, 1996
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