A Nonparametric Option Pricing Model Using Higher Moments

Cayton, Peter Julian (2015): A Nonparametric Option Pricing Model Using Higher Moments.

Abstract

A nonparametric model that includes non-Gaussian characteristics of skewness and kurtosis is proposed based on the cubic market capital asset pricing model. It is an equilibrium pricing model but risk-neutral valuation can be introduced through return data transformation. The model complies with the put-call parity principle of option pricing theory. The properties of the model are studied through simulation methods and compared with the Black-Scholes model. Simulation scenarios include cases on nonnormality in skewness and kurtosis, nonconstant variance, moneyness, contract duration, and interest rate levels. The proposed model can have negative prices in cases of out-of-money options and in simulation cases that are different from real-market situations, but the frequency of negative prices is reduced when risk-neutral valuation is implemented. The model is more adaptive and more conservative in pricing options compared to the Black-Scholes model when nonnormalities exist in the returns data.

• Item Type: MPRA Paper
• Language: English
• Keywords: Capital Asset Pricing Model, Call Options, Kurtosis, Skewness
• Subjects: C - Mathematical and Quantitative Methods > C1 - Econometric and Statistical Methods and Methodology: General > C14 - Semiparametric and Nonparametric Methods: General; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C51 - Model Construction and Estimation; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing; G - Financial Economics > G2 - Financial Institutions and Services > G23 - Non-bank Financial Institutions ; Financial Instruments ; Institutional Investors

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