On the Economic Premium Principle
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Date
2018-02
Authors
Journal Title
Journal ISSN
Volume Title
Publisher
Scientific Research
Abstract
In this study, we propose an equilibrium pricing rule to capture a characteristic
observed in the practical option market. The market has observed that the
implied volatility derived from the Black-Scholes formula is monotonically
decreasing with the strike price for the option, that is, it exhibits volatility
skewness. Here, we construct a pricing method for the so-called economic
premium principle. That is, we identify a pricing kernel from which we can
evaluate the derivative from the market equilibrium. Our model demonstrates
how to obtain a pricing kernel that satisfies the market equilibrium, and describes
our equilibrium formula depicting the volatility skewness.
Description
Keywords
Equilibrium Pricing, Pricing Kernel, Skewness
Citation
Theoretical Economics Letters, 2018, 8, 514-523