Displaced Jump-Diffusion Option Valuation

Posted: 25 Apr 2008 Last revised: 21 May 2019

See all articles by Antonio Camara

Antonio Camara

Oklahoma State University, Stillwater - College of Business Administration

Timothy L. Krehbiel

Oklahoma State University, Stillwater

Weiping Li

Civil Aviation Flight University of China ; Oklahoma State University

Date Written: May 27, 2008

Abstract

This paper extends the jump-diffusion option pricing model of Merton (1976) and the displaced diffusion option pricing model of Rubinstein (1983) to price options on stock indices. First, we provide a theory showing that the stock index value has a positive threshold or positive lower bound if the constituent firms of the index, when their equity falls below a given value, are replaced by new firms with higher equity. Second, using equilibrium arguments in an economy where the systematic jump risk of the stock index can not be eliminated, we derive a displaced jump-diffusion (DJD) option valuation model to price options written on stock indices. Third, we test empirically our DJD option pricing model using S&P 500 index options data from January 1996 through April 2006. The results of the tests strongly support our theories.

Suggested Citation

Camara, Antonio and Krehbiel, Timothy L. and Li, Weiping, Displaced Jump-Diffusion Option Valuation (May 27, 2008). Journal of Derivatives, Vol. 17, No. 2, 2009, https://doi.org/10.3905/JOD.2009.17.2.041, Available at SSRN: https://ssrn.com/abstract=1125142

Antonio Camara (Contact Author)

Oklahoma State University, Stillwater - College of Business Administration ( email )

201 Business
Stillwater, OK 74078-0555
United States

Timothy L. Krehbiel

Oklahoma State University, Stillwater ( email )

Stillwater, OK 74078-0555
United States

Weiping Li

Civil Aviation Flight University of China ( email )

46 Nanchang road
Guanghan, Sichuan 618307
China

Oklahoma State University ( email )

Stillwater, OK
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
1,872
PlumX Metrics