Skewed Generalized Error Distribution of Financial Assets and Option Pricing

Multinational Finance Journal, 2015, vol. 19, no. 4, pp. 223-266

50 Pages Posted: 13 May 2000 Last revised: 26 Aug 2019

Date Written: November 1, 2000

Abstract

This article investigates the empirical distributions of log-returns of several financial assets at the daily, weekly, monthly, bimonthly, and quarterly frequencies. The results indicate that the distributions possess significant skewness and leptokurtosis. These findings are attributed to strong higher-order moment dependencies which exist mainly in daily and weekly log-returns and prevent monthly, bimonthly, and quarterly log-returns from obeying the normality lawimplied by the central limit theorem. As a consequence, price changes do not follow the geometric Brownian motion often assumed in pricing options and other derivative assets. This article formally derives a skewed version of the Generalized Error Distribution (SGED) to model the empirical distribution of log-returns of financial assets and to price their call options. Under the assumptions of risk neutrality, normality of log-returns, and absence of arbitrage opportunities the SGED option-pricing model yields as special cases several well-known models for pricing options on stocks, stock indices, currencies, and currency futures.

Note: Previously titled "Distribution of Financial Asset Prices, the Skewed Generalized Error Distribution, and the Pricing of Options"

Keywords: Call option pricing, financial data, geometric Brownian motion, leptokurtosis, Laplace distribution, SGED

JEL Classification: C13,C22,G12,G13

Suggested Citation

Theodossiou, Panayiotis, Skewed Generalized Error Distribution of Financial Assets and Option Pricing (November 1, 2000). Multinational Finance Journal, 2015, vol. 19, no. 4, pp. 223-266, Available at SSRN: https://ssrn.com/abstract=219679 or http://dx.doi.org/10.2139/ssrn.219679

Panayiotis Theodossiou (Contact Author)

Ball State University ( email )

2000 W. University Ave
Muncie, IN Delaware 47306
United States