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What Type of Process Underlies Options? A Simple Robust Test

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  • Peter Carr

    (Bloomberg LP and the Courant Institute, New York University)

  • Liuren Wu

    (Zicklin School of Business, Baruch College, CUNY)

Abstract

We develop a simple robust method to distinguish the presence of continuous and discontinuous components in the price of an asset underlying options. Our method examines the prices of at-the-money and out-of-the-money options as the option's time-to-maturity approaches zero. We show that these prices converge to zero at speeds that depend upon whether the underlying asset price process is purely continuous, purely discontinuous, or a combination of both. We apply the method to S&P 500 index options and find the existence of both a continuous component and a jump component in the index. Copyright 2003 by the American Finance Association.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 58 (2003)
Issue (Month): 6 (December)
Pages: 2581-2610

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Handle: RePEc:bla:jfinan:v:58:y:2003:i:6:p:2581-2610

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