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No-Arbitrage Option Pricing: New Evidence on the Validity of the Martingale Property

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  • Menachem Brenner
  • Young Ho Eom
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    Abstract

    The no-arbitrage approach to option pricing implies that risk-neutral prices follow a martingale. The validity of this property has been tested and rejected by Longstaff (1995). Since he tested the general framework, his results have far reaching and disturbing implications for contingent claims pricing. This paper proposes a new method to test the martingale property. This method is based on the Laguerre polynomial series. The tests use options and futures on the S&P 500 index. The new methodology and data show that the martingale property cannot be rejected. This result implies that the general approach is still valid and the existence of frictions only adds noise. Testing more specific pricing models is relevant again.

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    Bibliographic Info

    Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 98-009.

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    Date of creation: Jun 1997
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    Handle: RePEc:fth:nystfi:98-009

    Contact details of provider:
    Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
    Phone: (212) 998-0100
    Web page: http://w4.stern.nyu.edu/finance/
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    Cited by:
    1. David Backus & Silverio Foresi & Liuren Wu, 2002. "Accouting for Biases in Black-Scholes," Finance 0207008, EconWPA.

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