Jian Chen,Chenghu Ma

Author information

a School of Economics, Xiamen University, Xiamen 361005, China

b School of Management, Fudan University, Shanghai 200433, China

E-mail: jchenl@xmu.edu.cn (Jian Chen), machenghu@fudan.edu.cn (Chenghu Ma)

Abstract

It is well known that volatility smirks and heavy-tailed asset return distributions are two violations of the Black-Scholes model. This paper investigates the role of jump size distribution played in explaining these two abnormalities. We consider a jump-diffusion model with Laplace jump size distribution, in comparison to the conventional normal distribution. In addition, our analysis is built upon a pure exchange economy, in which the representative agent’s risk preference shows a fanning characteristic. We find that, when a fanning effect is present, Laplace model produces a more remarkable leptokurtic pattern of the risk-neutral distribution implied by options, as well as generating more pronounced volatility smirks than the normal model.

Keywords

general equilibrium, recursive utility, option pricing, Laplace distribution, volatility smirk

Cite this article

Jian Chen, Chenghu Ma. Option Pricing Based on Alternative Jump Size Distributions. Front. Econ. China, 2016, 11(3): 439‒467 https://doi.org/10.3868/s060-005-016-0024-0