Option Pricing with Normal Mixture Returns: Modelling Excess Kurtosis and Uncertanity in Volatility
Abstracthis paper addresses the problem of uncertainty in volatility, and how this affects option prices. The volatility uncertainty adjustment to Black-Scholes option prices is quantified in this paper using a normal mixture model for the distribution of underlying returns, or equivalently, assuming a mixture of lognormal densities for the density of the asset price. The use of a lognormal mixture price process for pricing options is not new (Ritchey, 1990) but the local volatility that should be used in the lognormal mixture price process has only recently been established (Brigo and Mercurio, 2000a, 2001).
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Bibliographic InfoPaper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2001-10.
Length: 34 pages
Date of creation: Nov 2001
Date of revision: Dec 2001
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More information through EDIRC
Option Pricing with Normal Mixture Density Excess Kurtosis skewness; volatility uncertainty; exchange rates; equity indices;
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