The price of granularity and fractional finance

Charles Tapiero, Oren J. Tapiero, Guy Jumarie

Research output: Contribution to journalArticle

Abstract

The purpose of this paper is to assess the risk premium of a fractional financial lognormal (Black-Scholes) process relative to a non-fractional and complete financial markets pricing model. The intents of this paper are two-fold. On the one hand, provide a definition of the risk premium implied by the discount rate applied to future fractional returns relative to that of a non-fractional financial (and complete market) model. To do so, an insurance rationale is used to define a no-arbitrage risk neutral probability measure. On the other, highlight the effects of a model granularity and its Hurst index on financial risk models and their implications to risk management. In particular, we argue that fractional Brownian motion (BM) does not define a normal probability distribution but a fractional volatility model. To present simply the ideas underlying this paper, we price an elementary fractional risk free bond and its risk premium relative to a known spot interest rate. Similarly, the Black-Scholes no arbitrage model is presented in both its non-fractional conventional form and in its fractional framework. The granularity risk premium is then calculated.

Original languageEnglish (US)
Pages (from-to)7-21
Number of pages15
JournalRisk and Decision Analysis
Volume6
Issue number1
DOIs
StatePublished - Jan 14 2016

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Risk Premium
Granularity
Finance
Fractional
Black-Scholes
Arbitrage
Financial Risk
Model
Market Model
Discount
Fractional Brownian Motion
Risk Management
Interest Rates
Financial Markets
Insurance
Volatility
Probability Measure
Pricing
Gaussian distribution
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Keywords

  • Black-Scholes model
  • fractional finance
  • Granularity
  • pricing
  • risk premium

ASJC Scopus subject areas

  • Economics and Econometrics
  • Finance
  • Statistics, Probability and Uncertainty
  • Statistics and Probability

Cite this

The price of granularity and fractional finance. / Tapiero, Charles; Tapiero, Oren J.; Jumarie, Guy.

In: Risk and Decision Analysis, Vol. 6, No. 1, 14.01.2016, p. 7-21.

Research output: Contribution to journalArticle

Tapiero, Charles ; Tapiero, Oren J. ; Jumarie, Guy. / The price of granularity and fractional finance. In: Risk and Decision Analysis. 2016 ; Vol. 6, No. 1. pp. 7-21.
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