Option pricing when underlying stock returns are discontinuous

Pricing When Underlying Stock Returns Are Discontinuous

The validity of the classic Black-Scholes option pricing formula dcpcnds on the capability of investors to follow a dynamic portfolio strategy in the stock that replicates the payoff structure to the option. The critical assumption required for such a strategy to be feasible, is that the underlying stock return dynamics can be described by a stochastic process with a continuous sample path. In ...

Option Pricing when Underlying Process is Unknown

This paper proves that a simultaneously delta-neutral and gamma-neutral position can be established with the underlying asset and two options on the same asset, without any assumption on the underlying process of the asset price. This hedging strategy leads to the same fundamental partial differential equation as derived by Black and Scholes (1973), except that the variance function is the mark...

The Impact on Option Pricing of Specification Error in the Underlying Stock Price Returns

Path-Dependent Option Valuation When the Underlying Path Is Discontinuous

The payo s of path-dependent options depend not only on the nal values, but also on the sample paths of the prices of the underlying assets. A rigorous modeling of the underlying asset price processes which can appropriately describe the sample paths is therefore critical for pricing path-dependent options. This paper allows for discontinuities in the sample paths of the underlying asset prices...

American Finance Association The Impact on Option Pricing of Specification Error in the Underlying Stock Price Returns

The Impact on Option Pricing of Specification Error in the Underlying Stock Price Returns Author(s): Robert C. Merton Source: The Journal of Finance, Vol. 31, No. 2, Papers and Proceedings of the Thirty-Fourth Annual Meeting of the American Finance Association Dallas, Texas December 28-30, 1975 (May, 1976), pp. 333-350 Published by: Blackwell Publishing for the American Finance Association Stab...