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On the Economic Premium Principle
Faculty of Commerce, Nagoya University of Commerce and Business, Nisshin, Japan
- 1 Faculty of Commerce, Nagoya University of Commerce and Business, Nisshin, Japan
Theoretical Economics Letters·Volume 08 (2018)·Pages 514–523·Published 7 February 2018·DOI10.4236/tel.2018.83036
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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.
KeywordsEquilibrium PricingPricing KernelSkewness
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