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The Finite Moment Log Stable Process and Option Pricing (2002)
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@MISC{Carr02thefinite,
author = {Peter Carr and Liuren Wu},
title = { The Finite Moment Log Stable Process and Option Pricing},
year = {2002}
}
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Abstract
We document a surprising pattern in market prices of S&P 500 index options. When implied volatilities are graphed against a standard measure of moneyness, the implied volatility smirk does not flatten out as maturity increases up to the observable horizon of two years. This behavior contrasts sharply with the implications of many pricing models and with the asymptotic behavior implied by the central limit theorem (CLT). We develop a parsimonious model which deliberately violates the CLT assumptions and thus captures the observed behavior of the volatility smirk over the maturity horizon. Calibration exercises demonstrate its superior performance against several widely used alternatives.
Keyphrases
finite moment log stable process option pricing parsimonious model implied volatility implied volatility smirk superior performance surprising pattern volatility smirk observed behavior behavior contrast many pricing model standard measure observable horizon index option clt assumption asymptotic behavior market price maturity horizon central limit theorem
