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Black‐Scholes‐Merton revisited under stochastic dividend yields

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  • Abraham Lioui

Abstract

European options are priced in a framework à la Black‐Scholes‐Merton, which is extended to incorporate stochastic dividend yield under a stochastic mean–reverting market price of risk. Explicit formulas are obtained for call and put prices and their Greek parameters. Some well‐known properties of the Black‐Scholes‐Merton formula fail to hold in this setting. For example, the delta of the call can be negative and even greater than one in absolute terms. Moreover, call prices can be a decreasing function of the underlying volatility although the latter is constant. Finally, and most importantly, option prices highly depend on the features of the market price of risk, which does not need to be specified at all in the standard Black‐Scholes‐Merton setting. The results are simulated in order to assess the economic impact of assuming that the dividend yield is deterministic when it is actually stochastic, as well as to assess the economic importance of the features of the market price of risk. © 2006 Wiley Periodicals, Inc. Jrl Fut Mark 26:703–732, 2006

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  • Abraham Lioui, 2006. "Black‐Scholes‐Merton revisited under stochastic dividend yields," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 26(7), pages 703-732, July.
    • Handle: RePEc:wly:jfutmk:v:26:y:2006:i:7:p:703-732
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    Cited by:

    1. R. S. Tunaru, 2018. "Dividend derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 18(1), pages 63-81, January.
    2. Damir Filipovi'c & Sander Willems, 2018. "A Term Structure Model for Dividends and Interest Rates," Papers 1803.02249, arXiv.org, revised May 2020.
    3. Rodriguez, J.C., 2007. "Option Pricing and Momentum," Other publications TiSEM c3d95a76-1818-4543-87f5-b, Tilburg University, School of Economics and Management.
    4. Rodriguez, J.C., 2007. "A Preference-Free Formula to Value Commodity Derivatives," Other publications TiSEM 7354a9fa-3202-40c1-aeb2-a, Tilburg University, School of Economics and Management.

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