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Option prices as probabilities

Author

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  • Madan, D.
  • Roynette, B.
  • Yor, Marc

Abstract

Four distribution functions are associated with call and put prices seen as functions of their strike and maturity. The random variables associated with these distributions are identified when the process for moneyness defined as the stock price relative to the forward price is a positive local martingale with no positive jumps that tends to zero at infinity. Results on calls require moneyness to be a continuous martingale as well. It is shown that for puts the distributions in the strike are those for the remaining supremum while for calls, they relate to the remaining infimum. In maturity we see the distribution functions for the last passage times of moneyness to strike.

Suggested Citation

  • Madan, D. & Roynette, B. & Yor, Marc, 2008. "Option prices as probabilities," Finance Research Letters, Elsevier, vol. 5(2), pages 79-87, June.
  • Handle: RePEc:eee:finlet:v:5:y:2008:i:2:p:79-87
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    References listed on IDEAS

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    1. Breeden, Douglas T & Litzenberger, Robert H, 1978. "Prices of State-contingent Claims Implicit in Option Prices," The Journal of Business, University of Chicago Press, vol. 51(4), pages 621-651, October.
    2. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters,in: Theory Of Valuation, chapter 8, pages 229-288 World Scientific Publishing Co. Pte. Ltd..
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    4. Peter Carr & Helyette Geman & Dilip Madan & Marc Yor, 2004. "From local volatility to local Levy models," Quantitative Finance, Taylor & Francis Journals, vol. 4(5), pages 581-588.
    5. Peter Carr & Helyette Geman, 2002. "The Fine Structure of Asset Returns: An Empirical Investigation," The Journal of Business, University of Chicago Press, vol. 75(2), pages 305-332, April.
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    Cited by:

    1. Yuri Imamura, 2011. "A remark on static hedging of options written on the last exit time," Review of Derivatives Research, Springer, vol. 14(3), pages 333-347, October.
    2. Ashkan Nikeghbali & Eckhard Platen, 2008. "On Honest Times in Financial Modeling," Research Paper Series 229, Quantitative Finance Research Centre, University of Technology, Sydney.
    3. Libo Li, 2018. "From Az\'ema supermartingales of finite honest times to optional semimartingales of class-($\Sigma$)," Papers 1801.03873, arXiv.org.
    4. Amel Bentata & Marc Yor, 2008. "From Black-Scholes and Dupire formulae to last passage times of local martingales. Part A : The infinite time horizon," Papers 0806.0239, arXiv.org.
    5. D. Madan & B. Roynette & M. Yor, 2008. "Unifying BlackÔÇôScholes Type Formulae Which Involve Brownian Last Passage Times up to a Finite Horizon," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 15(2), pages 97-115, June.
    6. Ashkan Nikeghbali & Eckhard Platen, 2013. "A reading guide for last passage times with financial applications in view," Finance and Stochastics, Springer, vol. 17(3), pages 615-640, July.

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