TY - JOUR
T1 - Option Pricing Incorporating Factor Dynamics in Complete Markets
AU - Hu, Yuan
AU - Shirvani, Abootaleb
AU - Lindquist, W. Brent
AU - Fabozzi, Frank J.
AU - Rachev, Svetlozar T.
N1 - Publisher Copyright:
© 2020 by the authors.
PY - 2020/12
Y1 - 2020/12
N2 - Using the Donsker–Prokhorov invariance principle, we extend the Kim–Stoyanov–Rachev–Fabozzi option pricing model to allow for variably-spaced trading instances, an important consideration for short-sellers of options. Applying the Cherny–Shiryaev–Yor invariance principles, we formulate a new binomial path-dependent pricing model for discrete- and continuous-time complete markets where the stock price dynamics depends on the log-return dynamics of a market influencing factor. In the discrete case, we extend the results of this new approach to a financial market with informed traders employing a statistical arbitrage strategy involving trading of forward contracts. Our findings are illustrated with numerical examples employing US financial market data. Our work provides further support for the conclusion that any option pricing model must preserve valuable information on the instantaneous mean log-return, the probability of the stock’s upturn movement (per trading interval), and other market microstructure features.
AB - Using the Donsker–Prokhorov invariance principle, we extend the Kim–Stoyanov–Rachev–Fabozzi option pricing model to allow for variably-spaced trading instances, an important consideration for short-sellers of options. Applying the Cherny–Shiryaev–Yor invariance principles, we formulate a new binomial path-dependent pricing model for discrete- and continuous-time complete markets where the stock price dynamics depends on the log-return dynamics of a market influencing factor. In the discrete case, we extend the results of this new approach to a financial market with informed traders employing a statistical arbitrage strategy involving trading of forward contracts. Our findings are illustrated with numerical examples employing US financial market data. Our work provides further support for the conclusion that any option pricing model must preserve valuable information on the instantaneous mean log-return, the probability of the stock’s upturn movement (per trading interval), and other market microstructure features.
KW - Cherny–Shiryaev–Yor invariance principle
KW - Donsker–Prokhorov invariance principle
KW - informed traders
KW - path-dependent binomial option pricing
KW - statistical arbitrage based on forward contracts
UR - http://www.scopus.com/inward/record.url?scp=85109505702&partnerID=8YFLogxK
U2 - 10.3390/jrfm13120321
DO - 10.3390/jrfm13120321
M3 - Article
AN - SCOPUS:85109505702
SN - 1911-8074
VL - 13
JO - Journal of Risk and Financial Management
JF - Journal of Risk and Financial Management
IS - 12
M1 - 321
ER -