Pricing European Style Options

Posted: 31 Aug 2015 Last revised: 13 Sep 2018

Date Written: February 24, 2018

Abstract

The Black-Scholes option model created a revolution in finance. It was perceived that the model opened up a methodology to price option contracts. The methodology has been problematic as numerous empirical contradictions and anomalies have been noted. Born out of Frequentist decision theory, a key assumption in the formula is that all parameters are known. When viewed as an estimator, however, it is shown that it does not converge to a population parameter. Consequently, a new model is built using Bayesian decision theory rather than Frequentist decision theory. This is done as it assures that the estimator will be both admissible and coherent, something that cannot generally happen with existing methods using Ito calculus or binomial trees. The model proposed is derived in two distinct ways. The first is both distribution-free and presumes no first moment. The second follows the work of Harris in deriving the density functions of various asset classes. The former should be robust, the later, powerful.

Keywords: option pricing, Black-Scholes, Cauchy distribution, mean-variance finance, European style options

JEL Classification: G00, G13

Suggested Citation

Harris, David E., Pricing European Style Options (February 24, 2018). Available at SSRN: https://ssrn.com/abstract=2653255 or http://dx.doi.org/10.2139/ssrn.2653255

David E. Harris (Contact Author)

University of Providence ( email )

1301 20th Street South
Great Falls, MT 59405
United States
4067915341 (Phone)
4067915990 (Fax)

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