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Jump-diffusion option pricing with non-IID jumps

Author

Listed:
  • Lin Zou

    (Civil Aviation Flight University of China, Guanghan, Sichuan Province 618307, P. R. China)

  • António Câmara

    (Civil Aviation Flight University of China, Guanghan, Sichuan Province 618307, P. R. China)

  • Weiping Li

    (Civil Aviation Flight University of China, Guanghan, Sichuan Province 618307, P. R. China)

Abstract

This paper investigates how violations of the assumption that jumps are identically and independently distributed (IID) affect option prices. We characterize several types of IID jumps violations including jumps with time-varying means, time-varying variances, and time-varying autocorrelations, and analyze the combined effect of these violations on option prices. These IID violations affect option prices in different ways. Different effects of IID violations can either offset each other to eliminate the effect of isolated IID violations or can act as leverages increasing the magnitude of mispricing created by a single violation of the IID assumption. Our investigation is performed inside a new framework for the pricing of options that relaxes the assumption that jumps are IID. We derive three families of jump-diffusion option pricing formulae with non-IID jumps. Numerically and empirically, we show that the non-IID models can improve the BSM on the S&P 500 options for both in-samples and out-of-the-samples data in terms of SSE, AE and ARE.

Suggested Citation

  • Lin Zou & António Câmara & Weiping Li, 2025. "Jump-diffusion option pricing with non-IID jumps," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 12(03), pages 1-46, September.
    • Handle: RePEc:wsi:ijfexx:v:12:y:2025:i:03:n:s2424786323500469
    DOI: 10.1142/S2424786323500469
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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