Modeling Information Theory Effects on Price Uncertainty Using Multiple Agents with Heterogeneous Volatility

16 Pages Posted: 15 Feb 2015

See all articles by Edgar Parker

Edgar Parker

New York Life Insurance Company

Date Written: February 12, 2015

Abstract

A multiple agent model is developed where traders must receive, process, and send communications to and from a distant market. This model highlights the importance that information theory’s communication constraints have on the level of price uncertainty each agent faces. The collective uncertainty of many such agents leads to the nontrivial structure of the implied volatility surface. This type of analysis helps to reconcile traditional financial theory such as the Black-Scholes model with the realities seen in the financial markets. Apparent anomalies such as non-constant volatility across strikes and times to expiration are intuitively generated. Additionally the relationships established offer novel applications outside the realm of existing theories about uncertainty in finance and economics.

Keywords: financial engineering, information theory, Black-Scholes, implied volatility, econophysics

JEL Classification: G1, G12, G14, D84

Suggested Citation

Parker, Edgar, Modeling Information Theory Effects on Price Uncertainty Using Multiple Agents with Heterogeneous Volatility (February 12, 2015). Available at SSRN: https://ssrn.com/abstract=2564796 or http://dx.doi.org/10.2139/ssrn.2564796

Edgar Parker (Contact Author)

New York Life Insurance Company ( email )

51 Madison Avenue
New York, NY 10010
United States

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

Paper statistics

Downloads
99
Abstract Views
659
rank
360,773
PlumX Metrics