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Option Pricing in Markets with Informed Traders

Author

Listed:
  • Yuan Hu
  • Abootaleb Shirvani
  • Stoyan Stoyanov
  • Young Shin Kim
  • Frank J. Fabozzi
  • Svetlozar T. Rachev

Abstract

The objective of this paper is to introduce the theory of option pricing for markets with informed traders within the framework of dynamic asset pricing theory. We introduce new models for option pricing for informed traders in complete markets where we consider traders with information on the stock price direction and stock return mean. The Black-Scholes-Merton option pricing theory is extended for markets with informed traders, where price processes are following continuous-diffusions. By doing so, the discontinuity puzzle in option pricing is resolved. Using market option data, we estimate the implied surface of the probability for a stock upturn, the implied mean stock return surface, and implied trader information intensity surface.

Suggested Citation

  • Yuan Hu & Abootaleb Shirvani & Stoyan Stoyanov & Young Shin Kim & Frank J. Fabozzi & Svetlozar T. Rachev, 2020. "Option Pricing in Markets with Informed Traders," Papers 2006.02596, arXiv.org, revised Aug 2020.
    • Handle: RePEc:arx:papers:2006.02596
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    Cited by:

    1. Yuan Hu & Abootaleb Shirvani & W. Brent Lindquist & Frank J. Fabozzi & Svetlozar T. Rachev, 2020. "Option Pricing Incorporating Factor Dynamics in Complete Markets," JRFM, MDPI, vol. 13(12), pages 1-33, December.
    2. Yuan Hu & Abootaleb Shirvani & W. Brent Lindquist & Frank J. Fabozzi & Svetlozar T. Rachev, 2021. "Market Complete Option Valuation using a Jarrow-Rudd Pricing Tree with Skewness and Kurtosis," Papers 2106.09128, arXiv.org.
    3. Yuan Hu & Abootaleb Shirvani & W. Brent Lindquist & Frank J. Fabozzi & Svetlozar T. Rachev, 2020. "Option Pricing Incorporating Factor Dynamics in Complete Markets," Papers 2011.08343, arXiv.org.
    4. Svetlozar Rachev & Nancy Asare Nyarko & Blessing Omotade & Peter Yegon, 2023. "Bachelier's Market Model for ESG Asset Pricing," Papers 2306.04158, arXiv.org.
    5. Hu, Yuan & Lindquist, W. Brent & Rachev, Svetlozar T. & Shirvani, Abootaleb & Fabozzi, Frank J., 2022. "Market complete option valuation using a Jarrow-Rudd pricing tree with skewness and kurtosis," Journal of Economic Dynamics and Control, Elsevier, vol. 137(C).
    6. Davide Lauria & W. Brent Lindquist & Svetlozar T. Rachev & Yuan Hu, 2023. "Unifying Market Microstructure and Dynamic Asset Pricing," Papers 2304.02356, arXiv.org, revised Feb 2024.
    7. W. Brent Lindquist & Svetlozar T. Rachev, 2024. "Alternatives to classical option pricing," Papers 2403.17187, arXiv.org.
    8. Yuan Hu & W. Brent Lindquist & Svetlozar T. Rachev & Frank J. Fabozzi, 2023. "Option pricing using a skew random walk pricing tree," Papers 2303.17014, arXiv.org.

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