1option Pricing with V. G. Martingale Components

17 Pages Posted: 18 Apr 2008

See all articles by Dilip B. Madan

Dilip B. Madan

University of Maryland

Frank Milne

Queen's University - Department of Economics

Abstract

European call options are priced when the uncertainty driving the stock price follows the V. G. stochastic process (Madan and Seneta 1990). the incomplete markets equilibrium change of measure is approximated and identified using the log return mean, variance, and kurtosis. an exact equilibrium interpretation is also provided, allowing inference about relative risk aversion coefficients from option prices. Relative to Black-Scholes, V. G. option values are higher, particularly so for out of the money options with long maturity on stocks with high means, low variances, and high kurtosis.

Suggested Citation

Madan, Dilip B. and Milne, Frank, 1option Pricing with V. G. Martingale Components. Mathematical Finance, Vol. 1, Issue 4, pp. 39-55, October 1991, Available at SSRN: https://ssrn.com/abstract=1122043 or http://dx.doi.org/10.1111/j.1467-9965.1991.tb00018.x

Dilip B. Madan (Contact Author)

University of Maryland

Frank Milne

Queen's University - Department of Economics ( email )

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