Taking into account extreme events in European option pricing
AbstractAccording to traditional option pricing models, financial markets underestimate the impact of tail risk. In this article, we put forward a European option pricing model based on a set of assumptions that ensure, inter alia, that extreme events are better taken into account. Using simulations, we compare the option prices obtained from the standard Black and Scholes model with those resulting from our model. We show that the traditional model leads to an overvaluation of at-the-money options, which are the most traded options, while the less liquid in-the-money and out-of-the-money options are undervalued.
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Bibliographic InfoPaper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/5390.
Date of creation: Oct 2008
Date of revision:
Publication status: Published in Financial Stability Review, 2008, no. 12. pp. 39-51.Length: 12 pages
tail risk; option pricing models;
Other versions of this item:
- Idier, J. & Jardet, C. & Le Fol, G. & Monfort, A. & Pegoraro, J., 2008. "Taking into account extreme events in European option pricing," Financial Stability Review, Banque de France, issue 12, pages 39-51, October.
- G19 - Financial Economics - - General Financial Markets - - - Other
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- Avouyi-Dovi, S. & Idier, J., 2010.
"Central bank liquidity and market liquidity: the role of collateral provision on the French government debt securities market,"
278, Banque de France.
- Idier, Julien & Avouyi-Dovi, Sanvi, 2010. "Central bank liquidity and market liquidity: the role of collateral provision on the French government debt securities market," Economics Papers from University Paris Dauphine 123456789/11156, Paris Dauphine University.
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