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Option price and market instability

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  • Baaquie, Belal E.
  • Yu, Miao

Abstract

An option pricing formula, for which the price of an option depends on both the value of the underlying security as well as the velocity of the security, has been proposed in Baaquie and Yang (2014). The FX (foreign exchange) options price was empirically studied in Baaquie et al., (2014), and it was found that the model in general provides an excellent fit for all strike prices with a fixed model parameters—unlike the Black–Scholes option price Hull and White (1987) that requires the empirically determined implied volatility surface to fit the option data. The option price proposed in Baaquie and Cao Yang (2014) did not fit the data during the crisis of 2007–2008. We make a hypothesis that the failure of the option price to fit data is an indication of the market’s large deviation from its near equilibrium behavior due to the market’s instability. Furthermore, our indicator of market’s instability is shown to be more accurate than the option’s observed volatility. The market prices of the FX option for various currencies are studied in the light of our hypothesis.

Suggested Citation

  • Baaquie, Belal E. & Yu, Miao, 2017. "Option price and market instability," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 471(C), pages 512-535.
    • Handle: RePEc:eee:phsmap:v:471:y:2017:i:c:p:512-535
    DOI: 10.1016/j.physa.2016.11.080
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    References listed on IDEAS

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    1. Baaquie, Belal E. & Liang, Cui, 2007. "Pricing American options for interest rate caps and coupon bonds in quantum finance," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 381(C), pages 285-316.
    2. Orlin Grabbe, J., 1983. "The pricing of call and put options on foreign exchange," Journal of International Money and Finance, Elsevier, vol. 2(3), pages 239-253, December.
    3. Lishang Jiang, 2005. "Mathematical Modeling and Methods of Option Pricing," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 5855, February.
    4. Orlin J. Grabbe, "undated". "The Pricing of Call and Put Options on Foreign Exchange," Rodney L. White Center for Financial Research Working Papers 6-83, Wharton School Rodney L. White Center for Financial Research.
    5. Orlin J. Grabbe, "undated". "The Pricing of Call and Put Options on Foreign Exchange," Rodney L. White Center for Financial Research Working Papers 06-83, Wharton School Rodney L. White Center for Financial Research.
    6. Baaquie, Belal E. & Cao, Yang, 2014. "Option volatility and the acceleration Lagrangian," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 393(C), pages 337-363.
    7. Baaquie, Belal E. & Du, Xin & Bhanap, Jitendra, 2014. "Option pricing: Stock price, stock velocity and the acceleration Lagrangian," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 416(C), pages 564-581.
    8. Garman, Mark B. & Kohlhagen, Steven W., 1983. "Foreign currency option values," Journal of International Money and Finance, Elsevier, vol. 2(3), pages 231-237, December.
    9. Hull, John C & White, Alan D, 1987. "The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
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    Cited by:

    1. Yan, Hanhuan & Han, Liyan, 2019. "Empirical distributions of stock returns: Mixed normal or kernel density?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 514(C), pages 473-486.
    2. Belal Ehsan Baaquie & Muhammad Mahmudul Karim, 2023. "Pricing risky corporate bonds: An empirical study," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(1), pages 90-121, January.

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