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Taking into account extreme events in European option pricing

Idier, Julien; Jardet, Caroline; Le Fol, Gaëlle; Monfort, Alain; Pegoraro, Fulvio (2008), Taking into account extreme events in European option pricing, Financial Stability Review, 12, p. 39-51

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Type
Article accepté pour publication ou publié
Date
2008
Nom de la revue
Financial Stability Review
Numéro
12
Éditeur
Banque de France
Pages
39-51
Métadonnées
Afficher la notice complète
Auteur(s)
Idier, Julien
Jardet, Caroline
Le Fol, Gaëlle
Monfort, Alain
Pegoraro, Fulvio
Résumé (EN)
According to traditional option pricing models, financial markets underestimate the impact of tail risk. In this article, we put forward a European option pricing model based on a set of assumptions that ensure, inter alia, that extreme events are better taken into account. Using simulations, we compare the option prices obtained from the standard Black and Scholes model with those resulting from our model. We show that the traditional model leads to an overvaluation of at-the-money options, which are the most traded options, while the less liquid in-the-money and out-of-the-money options are undervalued.
Mots-clés
tail risk; option pricing models
JEL
G19 - Other