A relaxed lattice option pricing model: implied skewness and kurtosis
Purpose - The purpose of this paper is to develop an option pricing model applicable to US options. The lognormality assumption that has typically been imposed with past binomial and trinomial option pricing models is relaxed. The relaxed lattice model is then used to determine skewness and kurtosis of distributions of futures prices implied from option prices. Design/methodology/approach - The relaxed lattice is based on Gaussian quadrature. The markets studied include corn, soybeans, and wheat. Skewness and kurtosis are implied by minimizing the squared deviations of actual option premia from predicted premia. Findings - Positive skewness is the major source of nonnormality, but both skewness and kurtosis are important as the trinomial model that considers kurtosis has greater accuracy than the binomial model. The out-of-sample forecasting accuracy of the relaxed lattice models is better than the Black-Scholes model in most, but not all cases. Research limitations/implications - The model might benefit from using option prices from more than one day. The implied skewness and kurtosis were quite variable and using more data might reduce this variability. Practical implications - Empirical results mostly show positive implied skewness, which suggests extreme price rises were more likely than extreme price decreases. Originality/value - The relaxed lattice is a new model and the results about implied higher moments are new for these commodities. There are competing models available that should be able to get similar accuracy, so one key advantage of the new approach is its simplicity and ease of use.
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.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Volume (Year): 69 (2009)
Issue (Month): 3 (November)
|Contact details of provider:|| Web page: http://www.emeraldinsight.com|
|Order Information:|| Postal: Emerald Group Publishing, Howard House, Wagon Lane, Bingley, BD16 1WA, UK|
Web: http://emeraldgrouppublishing.com/products/journals/journals.htm?id=afr Email:
When requesting a correction, please mention this item's handle: RePEc:eme:afrpps:v:69:y:2009:i:3:p:268-283. 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: (Virginia Chapman)
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.