Advanced Search
MyIDEAS: Login to save this paper or follow this series

Future of option pricing: use of log logistic distribution instead of log normal distribution in Black Scholes model

Contents:

Author Info

  • Raja, Ammar
Registered author(s):

    Abstract

    Options are historically being priced using Black Scholes option pricing model and one of the prominent features of it is normal distribution. In this research paper I will calculate European call options using log logistic distribution instead of normal distribution. My argument is that a model with logistic distribution reflects better fit of option prices as compared to normal distribution. In this research paper I have used historic data on stocks, value European call options using both logistic and normal distribution and then finally compare the results in order to check the validity of my argument. What I have found is that European call options prices based on log logistic distribution better reflect stock prices on expiry date and Black Scholes Model based on normal distribution tend to overprice European call options. Another interesting fact is that before 1987 stock market crash, Black Scholes model valued options more correctly on average. But with time as the volatility of stocks increased and with more and more crashes normal distribution tend to underestimate the probability of default and thus generally overpriced options. At this point of time log logistic distribution is better serving the purpose but all depends on volatility of the stocks. If volatility levels further increase then fat tails of log logistic distribution have to become even fatter, that’s why keeping an eye on facts and incorporating all relevant variables in your model is very important. In finance there is never a universal truth every thing depends on what’s happening in the market.

    Download Info

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
    File URL: http://mpra.ub.uni-muenchen.de/40198/
    File Function: original version
    Download Restriction: no

    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 40198.

    as in new window
    Length:
    Date of creation: Nov 2009
    Date of revision:
    Handle: RePEc:pra:mprapa:40198

    Contact details of provider:
    Postal: Schackstr. 4, D-80539 Munich, Germany
    Phone: +49-(0)89-2180-2219
    Fax: +49-(0)89-2180-3900
    Web page: http://mpra.ub.uni-muenchen.de
    More information through EDIRC

    Related research

    Keywords: option pricing; black sholes model; logistic distribution; fat tailed distribution; options; derivatives; pricing;

    Find related papers by JEL classification:

    References

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
    as in new window
    1. Jackwerth, Jens Carsten & Rubinstein, Mark, 1996. " Recovering Probability Distributions from Option Prices," Journal of Finance, American Finance Association, American Finance Association, vol. 51(5), pages 1611-32, December.
    2. Simon Benninga, 2008. "Financial Modeling, 3rd Edition," MIT Press Books, The MIT Press, The MIT Press, edition 3, volume 1, number 0262026287, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Lists

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    Statistics

    Access and download statistics

    Corrections

    When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:40198. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Ekkehart Schlicht).

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.