Author(s)

Kazuhiro Takino

Faculty of Commerce, Nagoya University of Commerce and Business, Nisshin, Japan.

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.

Equilibrium Pricing, Pricing Kernel, Skewness

Takino, K. (2018) On the Economic Premium Principle. Theoretical Economics Letters, 8, 514-523. doi: 10.4236/tel.2018.83036.