Physics – Condensed Matter
Scientific paper
2004-01-12
Physics
Condensed Matter
9 pages, 3 figure. Contribution to the International Workshop on Trends and Perspectives on Extensive and Non-Extensive Statis
Scientific paper
10.1016/j.physa.2004.06.018
There is a well developed framework, the Black-Scholes theory, for the pricing of contracts based on the future prices of certain assets, called options. This theory assumes that the probability distribution of the returns of the underlying asset is a gaussian distribution. However, it is observed in the market that this hypothesis is flawed, leading to the introduction of a fudge factor, the so-called volatility smile. Therefore, it would be interesting to explore extensions of the Black-Scholes theory to non-gaussian distributions. In this contribution we provide an explicit formula for the price of an option when the distributions of the returns of the underlying asset is parametrized by an Edgeworth expansion, which allows for the introduction of higher independent moments of the probability distribution, namely skewness and kurtosis. We test our formula with options in the brazilian and american markets, showing that the volatility smile can be reduced. We also check whether our approach leads to more efficient hedging strategies of these instruments.
Balieiro Filho Ruy Gabriel
Rosenfeld Rogerio
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