Self-decomposability and option pricing

Peter Carr, Hélyette Geman, Dilip B. Madan, Marc Yor

Research output: Contribution to journalArticle

Abstract

The risk-neutral process is modeled by a four parameter self-similar process of independent increments with a self-decomposable law for its unit time distribution. Six different processes in this general class are theoretically formulated and empirically investigated. We show that all six models are capable of adequately synthesizing European option prices across the spectrum of strikes and maturities at a point of time. Considerations of parameter stability over time suggest a preference for two of these models. Currently, there are several option pricing models with 6-10 free parameters that deliver a comparable level of performance in synthesizing option prices. The dimension reduction attained here should prove useful in studying the variation over time of option prices.

Original languageEnglish (US)
Pages (from-to)31-57
Number of pages27
JournalMathematical Finance
Volume17
Issue number1
DOIs
StatePublished - Jan 2007

Fingerprint

Self-decomposability
Option Pricing
pricing
Costs
Independent Increments
Self-similar Processes
European Options
Dimension Reduction
Decomposable
strike
maturity
Model
Unit
Law
time
Decomposability
Option pricing
performance
Option prices

Keywords

  • Additive processes
  • Background Driving Lévy Processes
  • Ornstein-Uhlenbeck Processes
  • Scaling

ASJC Scopus subject areas

  • Accounting
  • Social Sciences (miscellaneous)
  • Finance
  • Economics and Econometrics
  • Applied Mathematics

Cite this

Self-decomposability and option pricing. / Carr, Peter; Geman, Hélyette; Madan, Dilip B.; Yor, Marc.

In: Mathematical Finance, Vol. 17, No. 1, 01.2007, p. 31-57.

Research output: Contribution to journalArticle

Carr, P, Geman, H, Madan, DB & Yor, M 2007, 'Self-decomposability and option pricing', Mathematical Finance, vol. 17, no. 1, pp. 31-57. https://doi.org/10.1111/j.1467-9965.2007.00293.x
Carr, Peter ; Geman, Hélyette ; Madan, Dilip B. ; Yor, Marc. / Self-decomposability and option pricing. In: Mathematical Finance. 2007 ; Vol. 17, No. 1. pp. 31-57.
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