Option Pricing with a Pentanomial Lattice Model that Incorporates Skewness and Kurtosis
AbstractThis paper analyzes a pentanomial lattice model for option pricing that incorporates skewness and kurtosis of the underlying asset. The lattice is constructed using a moment matching procedure, and explicit positivity conditions for branch probabilities are provided in terms of skewness and kurtosis. We also explore the limiting distribution of this lattice, which is compound Poisson, and give a Fourier transform based formula that can be used to more efficiently price European call and put options. An example illustrates some of the features of this model in capturing volatility smiles and smirks.
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Bibliographic InfoArticle provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.
Volume (Year): 14 (2007)
Issue (Month): 1 ()
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- Arturo Leccadito & Pietro Toscano & Radu S. Tunaru, 2012. "Hermite Binomial Trees: A Novel Technique For Derivatives Pricing," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(08), pages 1250058-1-1.
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