Risk-Neutral Parameter Shifts and Derivatives Pricing in Discrete Time

Authors

  • MARK SCHRODER

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    • Mark Schroder is at the Eli Broad Graduate School of Management, Michigan State University. I am grateful to Naveen Khanna, Hong Liu, an anonymous referee, and the editor, Richard Green, for comments and suggestions. This paper subsumes the earlier working paper “Preference-free Pricing of Contingent Claims in Discrete Time Models,” 1999.


ABSTRACT

We obtain a large class of discrete-time risk-neutral valuation relationships, or “preference-free” derivatives pricing models, by imposing a simple restriction on the state-price density process. The risk-neutral stock-return and forward-rate dynamics are obtained by changing only a location parameter, which can be determined independent of the preference and true location parameters. The Gaussian models of Rubinstein (1976), Brennan (1979), and Câmera (2003), and the gamma model of Heston (1993) are all special cases. The model provides simple relationships between expected returns and state-price density parameters analogous to the diffusion case.

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