IDEAS home Printed from https://ideas.repec.org/a/wsi/ijtafx/v05y2002i06ns0219024902001572.html
   My bibliography  Save this article

Distribution-Based Option Pricing On Lattice Asset Dynamics Models

Author

Listed:
  • YUJI YAMADA

    (Graduate School of Business Sciences, University of Tsukuba, 3-29-1 Otsuka, Bunkyo-ku, Tokyo 112-0012, Japan)

  • JAMES A. PRIMBS

    (Management Science and Engineering, Stanford University, Terman Engineering Center 700-327, CA 94305-4026, USA)

Abstract

In this paper, we propose a numerical option pricing method based on an arbitrarily given stock distribution. We first formulate a European call option pricing problem as an optimal hedging problem by using a lattice based incomplete market model. A dynamic programming technique is then applied to solve the mean square optimal hedging problem for the discrete time multi-period case by assigning suitable probabilities on the lattice, where the underlying stock price distribution is derived directly from empirical stock price data which may possess "heavy tails". We show that these probabilities are obtained from a network flow optimization which can be solved efficiently by quadratic programming. A computational complexity analysis demonstrates that the number of iterations for dynamic programming and the number of parameters in the network flow optimization are both of square order with respect to the number of periods. Numerical experiments illustrate that our methodology generates the implied volatility smile.

Suggested Citation

  • Yuji Yamada & James A. Primbs, 2002. "Distribution-Based Option Pricing On Lattice Asset Dynamics Models," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 5(06), pages 599-618.
    • Handle: RePEc:wsi:ijtafx:v:05:y:2002:i:06:n:s0219024902001572
    DOI: 10.1142/S0219024902001572
    as

    Download full text from publisher

    File URL: http://www.worldscientific.com/doi/abs/10.1142/S0219024902001572
    Download Restriction: Access to full text is restricted to subscribers
    File URL: https://libkey.io/10.1142/S0219024902001572?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Anda, Jon & Golub, Alexander & Strukova, Elena, 2009. "Economics of climate change under uncertainty: Benefits of flexibility," Energy Policy, Elsevier, vol. 37(4), pages 1345-1355, April.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wsi:ijtafx:v:05:y:2002:i:06:n:s0219024902001572. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Tai Tone Lim (email available below). General contact details of provider: http://www.worldscinet.com/ijtaf/ijtaf.shtml .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.