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Equilibruim approach of asset pricing under Lévy process

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  • Fu, Jun
  • Yang, Hailiang
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    Abstract

    This work considers the equilibrium approach of asset pricing for Lévy process. It derives the equity premium and pricing kernel analytically for the stock price process, obtains an equilibrium option pricing formula, and explains some empirical evidence such as the negative variance risk premium, implied volatility smirk, and negative skewness risk premium by comparing the physical and risk-neutral distributions of the log return. Different from most of the current studies in equilibrium pricing under jump diffusion models, this work models the underlying asset price as the exponential of a Lévy process and thus allows nearly an arbitrage distribution of the jump component.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0377221712004924
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    Bibliographic Info

    Article provided by Elsevier in its journal European Journal of Operational Research.

    Volume (Year): 223 (2012)
    Issue (Month): 3 ()
    Pages: 701-708

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    Handle: RePEc:eee:ejores:v:223:y:2012:i:3:p:701-708

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    Web page: http://www.elsevier.com/locate/eor

    Related research

    Keywords: Pricing; Equilibrium approach; Lévy process; Equity risk premium; Variance risk premium;

    References

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    1. Peter Carr & Liuren Wu, 2002. "Time-Changed Levy Processes and Option Pricing," Finance 0207011, EconWPA.
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    19. Jun Liu, 2005. "An Equilibrium Model of Rare-Event Premia and Its Implication for Option Smirks," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 131-164.
    20. Charles Quanwei Cao & Gurdip S. Bakshi & Zhiwu Chen, 1997. "Empirical Performance of Alternative Option Pricing Models," Yale School of Management Working Papers ysm65, Yale School of Management.
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    Cited by:
    1. Mitra, Sovan & Date, Paresh & Mamon, Rogemar & Wang, I-Chieh, 2013. "Pricing and risk management of interest rate swaps," European Journal of Operational Research, Elsevier, vol. 228(1), pages 102-111.
    2. Shen, Yang & Siu, Tak Kuen, 2013. "Stochastic differential game, Esscher transform and general equilibrium under a Markovian regime-switching Lévy model," Insurance: Mathematics and Economics, Elsevier, vol. 53(3), pages 757-768.

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