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Non-monotonic pricing kernel and an extended class of mixture of distributions for option pricing

Vitiello, L and Poon, SH (2014) 'Non-monotonic pricing kernel and an extended class of mixture of distributions for option pricing.' Review of Derivatives Research, 17 (2). 241 - 259. ISSN 1380-6645

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Abstract

© 2013, Springer Science+Business Media New York. We derive closed form European option pricing formulae under the general equilibrium framework for underlying assets that have an $$N$$N-mixture of transformed normal distributions. The component distributions need not belong to the same class but must all be transformed normal. An important implication of our results is that the mixture of distributions is consistent with a “what appears to be abnormal” non-monotonic (asset specific) pricing kernel for the S&P 500 and that the representative agent has a “logical” monotonic decreasing marginal utility. We show that a mixture of two lognormal distributions is sufficient to produce this result and also implied volatility smiles of a wide variety of shapes.

Item Type: Article
Subjects: H Social Sciences > HG Finance
Divisions: Faculty of Social Sciences > Essex Business School
Faculty of Social Sciences > Essex Business School > Essex Finance Centre
Depositing User: Users 161 not found.
Date Deposited: 11 Nov 2014 10:41
Last Modified: 01 Feb 2019 15:15
URI: http://repository.essex.ac.uk/id/eprint/11263

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