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No-Arbitrage Option Pricing: New Evidence on the Validity of the Martingale Property

42 Pages Posted: 7 Nov 2008  

Menachem Brenner

New York University (NYU) - Department of Finance

Young Ho Eom

Yonsei University

Date Written: June 1997

Abstract

The no-arbitrage approach to option pricing implies that risk-neutral prices follow a martingale. The validity of this property has been tested and rejected by Longstaff (1995). Since he tested the general framework, his results have far reaching and disturbing implications for contingent claims pricing. This paper proposes a new method to test the martingale property. This method is based on the Laguerre polynomial series. The tests use options and futures on the S&P 500 index. The new methodology and data show that the martingale property cannot be rejected. This result implies that the general approach is still valid and the existence of frictions only adds noise. Testing more specific pricing models is relevant again.

Keywords: Option Pricing, Martingale Pricing, Semi-Nonparametric Method

Suggested Citation

Brenner, Menachem and Eom, Young Ho, No-Arbitrage Option Pricing: New Evidence on the Validity of the Martingale Property (June 1997). NYU Working Paper No. FIN-98-009. Available at SSRN: https://ssrn.com/abstract=1296404

Menachem Brenner (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0323 (Phone)
212-995-4233 (Fax)

Young Ho Eom

Yonsei University ( email )

College of Business and Economics
Seoul 120-749
South Korea
+82 2 361 4193 (Phone)
+82 2 392 0504 (Fax)

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