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Heterogeneous Information Arrival and Option Pricing

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Author Info
Patrick K. Asea
Mthuli Ncube
Abstract

We model the arrival of heterogeneous information in a financial market as a doubly-stochastic Poisson process (DSPP). A DSPP is a member of the family of Poisson processes in which the mean value of the process itself is governed by a stochastic mechanism. We explore the implications for pricing stock, index and foreign currency options of the assumption that the under- lying security evolves as a mixed diffusion DSPP. We derive an intertemporal CAPM and demonstrate that accounting for heterogeneous information arrival may minimize the ubiquitous pricing bias 'smile-effect' of standard option pricing models. We propose a conceptually simple but numerically intensive maximum likelihood estimator of the parameters of a DSPP. A simulation study verifies the adequacy of the asymptotic approximations in finite samples.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5950.

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Date of creation: Mar 1997
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Handle: RePEc:nbr:nberwo:5950

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Find related papers by JEL classification:
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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  16. Huang, Chi-fu, 1987. "An Intertemporal General Equilibrium Asset Pricing Model: The Case of Diffusion Information," Econometrica, Econometric Society, vol. 55(1), pages 117-42, January. [Downloadable!] (restricted)
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