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Pricing Options on Assets with Predictable White Noise Returns

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  • Angel León
  • Enrique Sentana

Abstract

We study the effect of the predictability of an assets return on the prices of options on that asset, for models in which returns are serially uncorrelated, yet predictable on the basis of a larger information set. We show that return predictability may matter in a discrete time world, especially for longer maturity options. However, discrepancies between the frequency of trading and observation become relevant in estimating the model parameters. When trading is continuous, Black-Scholes is valid, and the sample variance of holding returns over finite periods is an appropriate estimator of the variance of instantaneous returns.

Suggested Citation

  • Angel León & Enrique Sentana, 1997. "Pricing Options on Assets with Predictable White Noise Returns," FMG Discussion Papers dp267, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp267
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    Cited by:

    1. Mencía, Javier & Sentana, Enrique, 2013. "Valuation of VIX derivatives," Journal of Financial Economics, Elsevier, vol. 108(2), pages 367-391.

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    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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