Equilibrium Asset and Option Pricing Under Jump Diffusion

31 Pages Posted: 8 Jun 2012

See all articles by Jin E. Zhang

Jin E. Zhang

University of Otago, Otago Business School, Department of Accountancy and Finance

Huimin Zhao

The University of Hong Kong

Eric C. Chang

University of Hong Kong - School of Business

Date Written: July 2012

Abstract

This paper develops an equilibrium asset and option pricing model in a production economy under jump diffusion. The model provides analytical formulas for an equity premium and a more general pricing kernel that links the physical and risk‚Äźneutral densities. The model explains the two empirical phenomena of the negative variance risk premium and implied volatility smirk if market crashes are expected. Model estimation with the S&P 500 index from 1985 to 2005 shows that jump size is indeed negative and the risk aversion coefficient has a reasonable value when taking the jump into account.

Keywords: asset pricing, option pricing, jump diffusion, equity risk premium, variance risk premium

Suggested Citation

Zhang, Jin E. and Zhao, Huimin and Chang, Eric Chieh C., Equilibrium Asset and Option Pricing Under Jump Diffusion (July 2012). Mathematical Finance, Vol. 22, Issue 3, pp. 538-568, 2012. Available at SSRN: https://ssrn.com/abstract=2079872 or http://dx.doi.org/10.1111/j.1467-9965.2010.00468.x

Jin E. Zhang (Contact Author)

University of Otago, Otago Business School, Department of Accountancy and Finance ( email )

Dunedin, 9054
New Zealand
64 3 479 8575 (Phone)
64 3 479 8171 (Fax)

HOME PAGE: http://sites.google.com/site/jinzhanghomepage/home

Huimin Zhao

The University of Hong Kong ( email )

School of Business, HKU,
Pokfulam Road
Hong Kong, Hong Kong HK
China
22415685 (Phone)

Eric Chieh C. Chang

University of Hong Kong - School of Business ( email )

Meng Wah Complex
Pokfulam Road
Hong Kong
China

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