General Equilibrium and Risk Neutral Valuation Framework for Option Pricing with Mixture of Distributions

https://doi.org/10.3905/jod.2008.707210

Manchester Business School Working Paper

Posted: 14 Aug 2006

See all articles by Luiz Vitiello

Luiz Vitiello

University of Essex - Essex Business School

Ser-Huang Poon

Alliance Manchester Business School, University of Manchester; Alan Turing Institute

Date Written: August 2006

Abstract

This paper develops a closed form risk-neutral valuation model for pricing European style options when the underlying has a mixture of transformed-normal distributions. Specifically, we introduce the mixture of g distributions, which contains the mixture of normal and lognormal distributions as a special case. The risk neutral valuation relation is developed following Rubinstein (1976), Brennan (1979) and Camara (2003). Our model encompasses several well known models, and is particularly useful for pricing derivatives written on illiquid assets, and derivatives that are themselves illiquid.

Keywords: General Equilibrium, G Distribution, Mixture of Distributions, Risk Neutral Valuation Relationship, Pricing Kernel, Option Pricing

JEL Classification: G12, G13, G22

Suggested Citation

Vitiello, Luiz and Poon, Ser-Huang, General Equilibrium and Risk Neutral Valuation Framework for Option Pricing with Mixture of Distributions (August 2006). https://doi.org/10.3905/jod.2008.707210, Manchester Business School Working Paper, Available at SSRN: https://ssrn.com/abstract=923964 or http://dx.doi.org/10.2139/ssrn.923964

Luiz Vitiello

University of Essex - Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Ser-Huang Poon (Contact Author)

Alliance Manchester Business School, University of Manchester ( email )

Alliance Manchester Business School
Booth Street West
Manchester, Manchester M15 6PB
United Kingdom
+44 161 275 4031 (Phone)
+44 161 275 4023 (Fax)

HOME PAGE: http://www.manchester.ac.uk/research/Ser-huang.poon/

Alan Turing Institute ( email )

British Library, 96 Euston Road
London, NW12DB
United Kingdom

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