We are indebted to Bob Webb (the Editor), the anonymous referee and seminar participants at the 2008 NTU International Conference on Finance, the 2009 Conference on Statistical Models and Methods in Quantitative Finance and Related Topics, and the 2009 European Financial Management Association Annual Meeting. The financial support of National Science Council of Taiwan is acknowledged.
A new simple square root option pricing model†
Article first published online: 24 FEB 2010
© 2010 Wiley Periodicals, Inc.
Journal of Futures Markets
Volume 30, Issue 11, pages 1007–1025, November 2010
How to Cite
Câmara, A. and Wang, Y.-h. (2010), A new simple square root option pricing model. J. Fut. Mark., 30: 1007–1025. doi: 10.1002/fut.20458
- Issue published online: 9 SEP 2010
- Article first published online: 24 FEB 2010
- Manuscript Accepted: JAN 2010
- Manuscript Received: NOV 2009
This study derives a simple square root option pricing model using a general equilibrium approach in an economy where the representative agent has a generalized logarithmic utility function. Our option pricing formulae, like the Black–Scholes model, do not depend on the preference parameters of the utility function of the representative agent. Although the Black–Scholes model introduces limited liability in asset prices by assuming that the logarithm of the stock price has a normal distribution, our basic square root option pricing model introduces limited liability by assuming that the square root of the stock price has a normal distribution. The empirical tests on the S&P 500 index options market show that our model has smaller fitting errors than the Black–Scholes model, and that it generates volatility skews with similar shapes to those observed in the marketplace. © 2010 Wiley Periodicals, Inc. Jrl Fut Mark