The Markov Tree model is a discrete-time option pricing model that accounts for short-term memory of the underlying asset. In this work, we compare the empirical performance of the Markov Tree model against that of the Black-Scholes model and Heston’s stochastic volatility model. Leveraging a total of five years of individual equity and index option data, and using three new methods for fitting...

In this paper we show that an arbitrary tree-like Markov chain can be embedded in a binary tree-like Markov chain with a special structure. When combined with [7], this implies that any tree structured QBD Markov chain can be reduced to a binary tree-like process. Furthermore, a simple relationship between the V , Rs and Gs matrices of the original and the binary tree-like Markov chain is estab...

This paper questions one of the fundamental assumptions made in options pricing: that the daily returns of a stock are independent and identically distributed (IID). We apply an estimation procedure to years of daily return data for all stocks in the French CAC-40 index. We find six stocks whose log returns are best modeled by a first-orderMarkov chain, not an IID sequence. We further propose t...