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A Jump-Diffusion Model for Option Pricing (2002)
| Venue: | Management Science |
| Citations: | 229 - 9 self |
BibTeX
@ARTICLE{Kou02ajump-diffusion,
author = {S. G. Kou},
title = {A Jump-Diffusion Model for Option Pricing},
journal = {Management Science},
year = {2002},
pages = {1086--1101}
}
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Abstract
Brownian motion and normal distribution have been widely used in the Black–Scholes option-pricing framework to model the return of assets. However, two puzzles emerge from many empirical investigations: the leptokurtic feature that the return distribution of assets may have a higher peak and two (asymmetric) heavier tails than those of the normal distribution, and an empirical phenomenon called “volatility smile ” in option markets. To incorporate both of them and to strike a balance between reality and tractability, this paper proposes, for the purpose of option pricing, a double exponential jump-diffusion model. In particular, the model is simple enough to produce analytical solutions for a variety of option-pricing problems, including call and put options, interest rate derivatives, and pathdependent options. Equilibrium analysis and a psychological interpretation of the model are also presented.
Keyphrases
option pricing jump-diffusion model normal distribution put option double exponential jump-diffusion model brownian motion psychological interpretation black scholes option-pricing framework interest rate derivative equilibrium analysis return distribution leptokurtic feature analytical solution option-pricing problem many empirical investigation pathdependent option option market volatility smile empirical phenomenon
