The Finite Moment Log Stable Process and Option Pricing
AbstractWe document a surprising pattern in market prices of S&P 500 index options. When implied volatilities are graphed against a standard measure of moneyness, the implied volatility smirk does not flatten out as maturity increases up to the observable horizon of two years. This behavior contrasts sharply with the implications of many pricing models and with the asymptotic behavior implied by the central limit theorem (CLT). We develop a parsimonious model which deliberately violates the CLT assumptions and thus captures the observed behavior of the volatility smirk over the maturity horizon. Calibration exercises demonstrate its superior performance against several widely used alternatives.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0207012.
Length: 42 pages
Date of creation: 30 Aug 2002
Date of revision:
Note: Type of Document - pdf; prepared on MikTex; to print on postscript; pages: 42 ; figures: included. produced via dvipdfm
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Volatility smirk; central limit theorem; Levy alpha-stable motion; selfsimilarity; option pricing.;
Other versions of this item:
- Peter Carr & Liuren Wu, 2003. "The Finite Moment Log Stable Process and Option Pricing," Journal of Finance, American Finance Association, vol. 58(2), pages 753-778, 04.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- F31 - International Economics - - International Finance - - - Foreign Exchange
- C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
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