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Martingalized Historical approach for Option Pricing

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  • Christophe Chorro

    (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)

  • Dominique Guegan

    (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

  • Florian Ielpo

    (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)

Abstract

In a discrete time option pricing framework, we compare the empirical performance of two pricing methodologies, namely the affine stochastic discount factor (SDF) and the empirical martingale correction methodologies. Using a CAC 40 options dataset, the differences are found to be small: the higher order moment correction involved in the SDF approach may not be that essential to reduce option pricing errors. This paper puts into evidence the fact that an appropriate modelling under the historical measure associated with an adequate correction (that we call here a "martingale correction") permits to provide option prices which are close to market ones.

Suggested Citation

  • Christophe Chorro & Dominique Guegan & Florian Ielpo, 2010. "Martingalized Historical approach for Option Pricing," PSE-Ecole d'économie de Paris (Postprint) halshs-00437927, HAL.
    • Handle: RePEc:hal:pseptp:halshs-00437927
    DOI: 10.1016/j.frl.2009.11.002
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00437927
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    References listed on IDEAS

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    1. Mercuri, Lorenzo, 2008. "Option pricing in a Garch model with tempered stable innovations," Finance Research Letters, Elsevier, vol. 5(3), pages 172-182, September.
    2. Jin-Chuan Duan & Jean-Guy Simonato, 1998. "Empirical Martingale Simulation for Asset Prices," Management Science, INFORMS, vol. 44(9), pages 1218-1233, September.
    3. Giovanni Barone-Adesi & Robert F. Engle & Loriano Mancini, 2007. "A GARCH Option Pricing Model in Incomplete Markets," Swiss Finance Institute Research Paper Series 07-03, Swiss Finance Institute.
    4. Robert J. Elliott & Dilip B. Madan, 1998. "A Discrete Time Equivalent Martingale Measure," Mathematical Finance, Wiley Blackwell, vol. 8(2), pages 127-152, April.
    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
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    Cited by:

    1. Christophe Chorro & Dominique Guegan & Florian Ielpo, 2012. "Option Pricing for GARCH-type Models with Generalized Hyperbolic Innovations," PSE-Ecole d'économie de Paris (Postprint) hal-00511965, HAL.
    2. Marius-Cristian Frunza & Dominique Guegan, 2010. "Risk Assessment for a Structured Product Specific to the CO2 Emission Permits Market," Post-Print halshs-00504209, HAL.
    3. Christophe Chorro & Dominique Guegan & Florian Ielpo, 2010. "Likelihood-Related Estimation Methods and Non-Gaussian GARCH Processes," Post-Print halshs-00523371, HAL.

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