Delta Hedged Option Valuation with Underlying Non-Gaussian Returns
arXiv:physics/0602048 · doi:10.1016/j.physa.2007.01.018
Abstract
The standard Black-Scholes theory of option pricing is extended to cope with underlying return fluctuations described by general probability distributions. A Langevin process and its related Fokker-Planck equation are devised to model the market stochastic dynamics, allowing us to write and formally solve the generalized Black-Scholes equation implied by dynamical hedging. A systematic expansion around a non-perturbative starting point is then implemented, recovering the Matacz's conjectured option pricing expression. We perform an application of our formalism to the real stock market and find clear evidence that while past financial time series can be used to evaluate option prices before the expiry date with reasonable accuracy, the stochastic character of volatility is an essential ingredient that should necessarily be taken into account in analytical option price modeling.
Four pages; two eps figures
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- Student's t-Distribution Based Option Sensitivities: Greeks for the Gosset Formulae
- Homogeneously Saturated Model for Development in Time of the Price of an Asset