TITLE:
On the Economic Premium Principle
AUTHORS:
Kazuhiro Takino
KEYWORDS:
Equilibrium Pricing, Pricing Kernel, Skewness
JOURNAL NAME:
Theoretical Economics Letters,
Vol.8 No.3,
February
14,
2018
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.