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Equilibrium approach of asset and option pricing under Lévy process and stochastic volatility

Author

Listed:
  • Shuang Li

    (Department of Mathematics and Statistics, Curtin University, Australia)

  • Yanli Zhou

    (School of Finance, Zhongnan University of Economics and Law, China)

  • Yonghong Wu

    (Department of Mathematics and Statistics, Curtin University, Australia; School of Statistics and Mathematics, Zhongnan University of Economics and Law, China)

  • Xiangyu Ge

    (School of Statistics and Mathematics, Zhongnan University of Economics and Law, China)

Abstract

This paper studies the equity premium and option pricing under the general equilibrium framework taking into account stochastic volatility. We establish analytical expressions for the equity premium and pricing kernel of the stock process. Moreover, the equilibrium option pricing formula is derived by the Fourier transformation method. Numerical results show that our model is superior to the previous model with constant volatility in explaining some financial phenomena, such as negative variance risk premium, implied volatilities and negative skewness risk premium. As the price of the underlying asset is modeled as the exponential of the Lévy process with stochastic volatility, our model is more general than the existing equilibrium pricing models.

Suggested Citation

  • Shuang Li & Yanli Zhou & Yonghong Wu & Xiangyu Ge, 2017. "Equilibrium approach of asset and option pricing under Lévy process and stochastic volatility," Australian Journal of Management, Australian School of Business, vol. 42(2), pages 276-295, May.
    • Handle: RePEc:sae:ausman:v:42:y:2017:i:2:p:276-295
    DOI: 10.1177/0312896215619966
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Equity premium; equilibrium framework; Lévy process; option pricing; stochastic volatility;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C62 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Existence and Stability Conditions of Equilibrium
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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