RIS ID

115008

Publication Details

Zhu, S. & He, X. (2017). A new closed-form formula for pricing European options under a skew Brownian motion. The European Journal of Finance, Online First 1-13.

Abstract

In this paper, we present a new pricing formula based on a modified Black-Scholes (B-S) model with the standard Brownian motion being replaced by a particular process constructed with a special type of skew Brownian motions. Although Corns and Satchell [2007. "Skew Brownian Motion and Pricing European Options." The European Journal of Finance 13 (6): 523-544] have worked on this model, the results they obtained are incorrect. In this paper, not only do we identify precisely where the errors in Although Corns and Satchell [2007. "Skew Brownian Motion and Pricing European Options". The European Journal of Finance 13 (6): 523-544] are, we also present a new closed-form pricing formula based on a newly proposed equivalent martingale measure, called 'endogenous risk neutral measure', by which only endogenous risks should and can be fully hedged. The newly derived option pricing formula takes the B-S formula as a special case and it does not induce any significant additional burden in terms of numerically computing option values, compared with the effort involved in computing the B-S formula.

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Link to publisher version (DOI)

http://dx.doi.org/10.1080/1351847X.2017.1339104