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No-Arbitrage Option Pricing: New Evidence on the Validity of the Martingale Property

Author

Listed:
  • Menachem Brenner
  • Young Ho Eom

Abstract

The no-arbitrage approach to option pricing implies that risk-neutral prices follow a martingale. The validity of this property has been tested and rejected by Longstaff (1995). Since he tested the general framework, his results have far reaching and disturbing implications for contingent claims pricing. This paper proposes a new method to test the martingale property. This method is based on the Laguerre polynomial series. The tests use options and futures on the S&P 500 index. The new methodology and data show that the martingale property cannot be rejected. This result implies that the general approach is still valid and the existence of frictions only adds noise. Testing more specific pricing models is relevant again.

Suggested Citation

  • Menachem Brenner & Young Ho Eom, 1997. "No-Arbitrage Option Pricing: New Evidence on the Validity of the Martingale Property," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-009, New York University, Leonard N. Stern School of Business-.
  • Handle: RePEc:fth:nystfi:98-009
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    Cited by:

    1. David Backus & Silverio Foresi & Liuren Wu, 2002. "Accouting for Biases in Black-Scholes," Finance 0207008, EconWPA.
    2. Damien Ackerer & Damir Filipovic & Sergio Pulido, 2017. "The Jacobi Stochastic Volatility Model," Working Papers hal-01338330, HAL.
    3. Bogdan Negrea & Bertrand Maillet & Emmanuel Jurczenko, 2002. "Skewness and Kurtosis Implied by Option Prices: A Second Comment," FMG Discussion Papers dp419, Financial Markets Group.
    4. Torben G. Andersen & Luca Benzoni & Jesper Lund, 2002. "An Empirical Investigation of Continuous-Time Equity Return Models," Journal of Finance, American Finance Association, vol. 57(3), pages 1239-1284, June.
    5. repec:oup:rapstu:v:7:y:2017:i:1:p:2-42. is not listed on IDEAS
    6. Jackwerth, Jens Carsten, 1999. "Option Implied Risk-Neutral Distributions and Implied Binomial Trees: A Literature Review," MPRA Paper 11634, University Library of Munich, Germany.
    7. Bogdan Negrea & Bertrand Maillet & Emmanuel Jurczenko, 2002. "Revisited Multi-moment Approximate Option," FMG Discussion Papers dp430, Financial Markets Group.
    8. Damien Ackerer & Damir Filipovi'c & Sergio Pulido, 2016. "The Jacobi Stochastic Volatility Model," Papers 1605.07099, arXiv.org, revised Mar 2018.
    9. repec:oup:rasset:v:7:y:2017:i:1:p:2-42. is not listed on IDEAS
    10. repec:wyi:journl:002157 is not listed on IDEAS

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