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Option Pricing With V. G. Martingale Components

  • Frank Milne

    ()

    (Queen's University)

  • Dilip Madan

    (University of Maryland)

European call options are priced when the uncertainty driving the stock price follows the V. G. stochastic process (Madan and Seneta 1990). The incomplete markets equilibrium change of measure is approximated and identified using the log return mean, variance, and kurtosis. An exact equilibrium interpretation is also provided, allowing inference about relative risk aversion coefficients from option prices. Relative to Black-Scholes, V. G. option values are higher, particularly so for out of the money options with long maturity on stocks with high means. low variances, and high kurtosis.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_1159.pdf
File Function: First version 1991
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Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1159.

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Length: 17 pages
Date of creation: Oct 1991
Date of revision:
Publication status: Published in Mathematical Finance, Vol. 1, No. 4 (October 1991), 39-55
Handle: RePEc:qed:wpaper:1159
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