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Option pricing under market maker's inventory risk: A case study of China

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  • Deng, Zhijian
  • Yao, Yuhang

Abstract

Recently the pivotal role of financial intermediaries, especially market makers, in the domain of option pricing has received significant attention. This study advances the modeling framework introduced by Fournier (2020) by incorporating market maker's inventory risk into option pricing for the Chinese market. Building on empirical findings, the dynamic of the ratio of market makers’ inventory risks to wealth is modified as continuous GARCH model. Moreover, we propose a general and innovative analytical formulation for option pricing and implied volatility, utilizing the auxiliary model method. The concluding empirical tests affirm the enhanced accuracy of our model over conventional approaches.

Suggested Citation

  • Deng, Zhijian & Yao, Yuhang, 2024. "Option pricing under market maker's inventory risk: A case study of China," Finance Research Letters, Elsevier, vol. 66(C).
    • Handle: RePEc:eee:finlet:v:66:y:2024:i:c:s1544612324006469
    DOI: 10.1016/j.frl.2024.105616
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    References listed on IDEAS

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