Building a Consistent Pricing Model from Observed Option Prices

Stanford University, Hoover Institution Working Paper No. B-443

25 Pages Posted: 22 Jan 1999

See all articles by Dietmar Leisen

Dietmar Leisen

Johannes Gutenberg University Mainz - Department of Banking

Jean-Paul Laurent

University Paris 1 Panthéon - Sorbonne, PRISM Sorbonne & Labex ReFi

Date Written: December 9, 1998

Abstract

This paper constructs a model for the evolution of a risky security that is consistent with a set of observed call option prices. It explicitly treats the fact that only a discrete data set can be observed in practice. The framework is general and allows for state dependent volatility and jumps. The theoretical properties are studied. An easy procedure to check for arbitrage opportunities in market data is proved and then used to ensure the feasibility of our approach. The implementation is discussed: testing on market data reveals a U-shaped form for the "local volatility" depending on the state and, surprisingly, a large probability for strong price movements.

JEL Classification: C51, G12, G13

Suggested Citation

Leisen, Dietmar P. J. and Laurent, Jean-Paul, Building a Consistent Pricing Model from Observed Option Prices (December 9, 1998). Stanford University, Hoover Institution Working Paper No. B-443, Available at SSRN: https://ssrn.com/abstract=145370 or http://dx.doi.org/10.2139/ssrn.145370

Dietmar P. J. Leisen (Contact Author)

Johannes Gutenberg University Mainz - Department of Banking ( email )

Jakob-Welder-Weg 9
Mainz, D-55099
Germany
++49-6131-39 22097 (Phone)
++49-6131-39 23971 (Fax)

HOME PAGE: http://www.finserv.bwl.uni-mainz.de/index_ENG.php

Jean-Paul Laurent

University Paris 1 Panthéon - Sorbonne, PRISM Sorbonne & Labex ReFi ( email )

France

HOME PAGE: http://laurent.jeanpaul.free.fr/

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
869
Abstract Views
2,512
rank
34,222
PlumX Metrics