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Building A Consistent Pricing Model From Observed Option Prices

In: Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume II)

Author

Listed:
  • JEAN-PAUL LAURENT

    (Center for Research in Economics and Statistics, Finance Department, 15 Boulevard Gabriel Péri, 92245 Malakoff Cedex, France)

  • DIETMAR P. J. LEISEN

    (Stanford University, Hoover Institution, Stanford, CA 94305, USA)

Abstract

This paper constructs a model for the evolution of a risky security that is consistent with a set of observed call option prices. It explicitly treats the fact that only a discrete data set can be observed in practice. The framework is general and allows for state dependent volatility and jumps. The theoretical properties are studied. An easy procedure to check for arbitrage opportunities in market data is proven and then used to ensure the feasibility of our approach. The implementation is discussed: testing on market data reveals a U-shaped form for the "local volatility" depending on the state and surprisingly, a large probability for strong price movements.

Suggested Citation

  • Jean-Paul Laurent & Dietmar P. J. Leisen, 2001. "Building A Consistent Pricing Model From Observed Option Prices," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume II), chapter 8, pages 216-238, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789812810663_0008
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