COMMO- S':OCK VOLATILITIES IH OPT!

N- FO&~LA5

I -

by

- Edwa!!d ~ Thoro

Un iVEl:'S' icy of CaL':',fornl.s, Irvine

DEPARTMENT OF MATHEMATICS.

UNIVE:R.SITY IOF CALIFO'RNIA IRVINE

I

1

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S'EM~N,AR OIN 'THE ,ANAL YS:IS OF SECU~RlTY PRICES

1_. J

MAY 1'976

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CENTER :F'Q'R RESEAR,CH IN SECU RtTY PRICES

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GRADUATE SCHOOl, or BUS~NESS THE UN~VERSITY OF CHICAC'O'

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~e ~ee~.s ort ~b~ S~~ Oll t~ ;.11~si.s oi' S~ii.:Y' P.ri~~5 a::-e' c1!'e-~~ei ]IlCiV'l~teb' ''b;rthe' Ceo:l!::,~ f:~;_~:se!..-.;::hi"" 8ee'W"iq ?::-!ees of tk~ Umvers,it.y of' cm.~o. ~t.e. ~c:e~s, aFP~a;r 'L'*"t~ the 5~i ac"'Y1'-ua' meetings i:llM:~iY' ,eind No;Q'~:ber and are ~e ea.v'S.iI.:e.b1.e: on1_y to mfoscr:::'b!!',e' me!!l:be~;;; of' the.Se:m:t.na.r a~, toa.c ~emilC l!'b(re.ri~s. fm't ici pi!. t :len :i:!. 'the S~'ii 1!1i~ is ''Qy ~year:Ly subscript ;i,.'CD. of $3000. Academlcli b\!."sries!'l!.e,\f obtai.:! tb.e li?roeeed.i.fi5:ii fo:r 1ll.:il e..nn~e.l~e~ of $6o~ or$JO per h,S'U.e. ~ o!":':.J..e p;e.pe:r:;::, p!"€!sle:!l,ted. to the .8ei~e.Tar!:'r~g ot ter!.ti!!.tive =~II!~S -;r-.E:!i. ~ :~' :e:u:":;h~:5: d.o :n,Ql; :;'''i::;:h ~Q )"'i eL1It1~5'~e:!:'B. -l'y ~ve.i2e:bJ.,e '\mti ~ ~k.~!" ~1!!,5ea:.~b ~ bee!:!., do:ne. Ti!!.e=F'i1"~e'l :;:1:!.e ~Q(:e~s ere c:i:reul.~e:ii

,:!",i; .-a:~ ~:..:si.o1. th ~he 1~>e5:S ~~'~ 2i:!i:! d~ - ge~ ~ ':Jauer .. "'!:.!. ~e~he:"

;.Q-rli"'l!"!!.i'i ..... ~ ... - ~ ...... t"'~ ::""",~'L. ...... ~ -h .. '._"1 ... _ '_.'" ... _,.,.....: ,,,,,,'jj:"'" - ... "" ....... ,""' "' ..... 11._~ (,~ \

.li. :_~.":'J ~~!.i!I,'I,:",i '=\£J 'i;.!!":'" '~~ . ~ !I,r~. 'ifIl.4l". ~~'Ioi!I!!i!I; ~ !:.I\_.~ I~i!!!i;; ... d ""'~, !f"!iiiiiO:.ll.,~a!iiiiij ,_.'I;J";;";;' 1WI..l. ~Jb!i,""" !§iiJ!!/1!.iiI;,~_~-. ~'iIi

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J~e.s, E:~ ~::e: ~ D:Uc~~%.o~ ~ S~'i ",.",(,.., o.!t't:he • .t!:l.a:.ysis, of Security ~ces M;yr~ Sclwl~s: ~ Dil"iecior ~ CeJ:!,~e';!"::orH:eSei2'en. ii:l. S~cUl"it;yPTices ~'&o'rn'"el!lc'e'Fish.el" ~ As;;,;ociat,e, D'rr~ctor

wi ~i -j .i~ SpW1gl ~ J$,en;l,or :ProgZ''9cmmm:'

~'l"f.n Lipson" Pl"ogr:~e:l" .A:Ila.i.y:st

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&Ctru. .i o :-es .1' 3ili:t.Q!" C"'g..., .... l~5 eo;'i So Zio~els ~

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'flle Ge,!!ter fQr ~e5f!ar'ch in S>e:e;Ur':'-yh":',ces, ( s~,olill~ored, QyM'~l!:T1.:.l .L,r_c~:~ F'ie:rce i Fenn€!1' & Sm.i to ~ In,c.) Ls looated at t.he Gre:.du.a.te School elL ~iI1le$:l; of: the' Uni ller ~i t Y' of Chi ca.so { 583E C"'l"e eJ:lTiOTOod A ;ret!1!.l€: I, Chi c ago, IlliDO 19 606:31, 312'- 53--b:262).

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:;o:..:~ :1l:E !£'2_'!~ " ~.mJ OO:!J)~ _'_:j~:IG~~ '":.'::: -is • .r 0 i:u! G. MdJonBl_d

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RISK.'lU'iD COMPOUND R~ • iichard 0" Mie:naud

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C!l-~OJ :?AC'.:'OR:S!!l STOCK R~"'1S. ~ ::.L~c:F:l.o:EcCONo!!IC Co."ili.."!\iii!T JlTESilolID ~O;:SC:;:CC1i{L1\.fiC !'JE!'~..:I~S •

~:' .3:c5e_~'b~:rg 1Uld. V~~y ~~!!rt,-:::;

:'E $.;??:':: C3' 00._-.. _' il,WF::s:c.c rc:-; -:C;~ .:.r-:~' 3. :_d"'~e'

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1,?':;",:}5.';'~:On C082S, A.:.~ Im~;$T A..~.Bl.!,21~~: ~ .. .cn:ro_L V'Ep..suS 'TIJ~BU:':-"f! e~:OD5.

J~cob A.. F::renke~ and RiebardM. :t~vich

.13.1

QjJJl.l~:TEfI LY ll\C COOIfrING DA~A; TIME- SfEfIB8 P!\OPEFl'I"I~ AND Fa EDICTIllE ~3!k~Y 3.ESUT.fi1$ '"

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u-a.:NO rss BL-!!"CK~SCHOL~ OPl"!O!iT ~.lOD.~ D IWl~~DECISION~_!_4KING ~ DES!.GNING A, CONV~TII!L,E Ml-U~ED ISSIj~

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·,271

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COMMON STOCK V'OUl.. __ :U:~ IN' OPT'rON' FORHlJtAS

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EdTomrd 0,. Thorp University 0..::' Calif'Ol"'n" a, Irvi,ne

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_l.!e Bl;~ck-Sc;ho1.es formula. valu,e :'o.l!:" a. ca.ll option on a s,t.ock. r;oMch . . pe:_y:s; 0,0 d,i vid~nds durci ng the li.f e. of tbe call, depends on. just t'ioiiO .par~~ters . They are "t.he" r ':'skiess re:te ot' interest r a.ndthe vo.lati.l.ity V' of the undeorlying comacn s;tock. Uncertairl'ti,ss in ei tlt!er l' or v lead to unc erta.imt.i es in. tlb.~ c a.L cule,t ed call

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option pr1c'e.

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'·-,e ~ .. "'ish to liet.,e;nnine r and "fiT ror t:_e ope Lon f'ormul.a in such a

fi8..Y as to either ( a ) improV\e t be f'i.t 0 t ;;; he node.L pr-Ie es to. observed, past and. fut1ll"e option Pl'icles~ or fib) -0 make tn,e f01'1ll.ula pric.es a !ilIOre; effective tool f'or' ca.pt.ur':r!g ezcess ret"UrllS in the market p~a.ce'. Thi.s cor-r-esponds t.o the ,clas:si.i'::,ca..ti,oln o,f'models as (1) descri,pti-we (i .e,. fits data), (2) predicti.ve {i .e .. modl81s based on deductioltl. f~Q_ principles, ,guided by the da""'e a!!l!.d. designed not only t.o fit the pe.st bu.t to fo,recast (f.i t) th.e f'lIJl~1!IT'.e:);, ~ (3) pr~scripti ve or no rmat. i we b!od..e:l.s which achieve certain 'c'r'iteria. or .obj e~ti ves ) • See Thorp

[:2 -] and M-orgenstern (24] ,.

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The;Black-8chol.~smod€ll_ Ls no~:tive; the call opt,ion pricev(~.,t)

Ls a C2 {continuous second. pa.."l""t.ia.! derivatives} function such teat [under- - he.':'r ~.S$umptiom;) a. hedge ~ co~t':'nous.ly ad.just,ed. 50 as, t.o-be riskless,~ will yield t.he' risti,es$ rate of re-turn., Black and Scholes [5, tbe:n test i:;.b.e formula to see if' it. :1.$ a_so (I) (from which we expect it

!I.as ,a good chance. t.o be (2) ).

I' • -

.Not.e tha.t t.h,e model cou.!,d be ( 3) ~ but nat ( 2 ) or- (l), &1.d yet ":le (b),

235

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providing at,ool for excess r'et.urm;.. Hene e ( a" 01" ( b ) can eac h. be 1li:l~e:pe!!ldJenrt~y t!'ueoI' fals·e.. These 'observa:"tions aIle cri tica.JL for tbe use of'th.etheory to .gain exe.ess retu..'rtls i:n thema.rket. Yet they ar'~· us:uaUy 19n.o(l'l'!ld in tb,e· liteGt."sr:'"W".e .1iIor e'xampl,e; the (no_~tivle) "theory says a very a..eep la. themouey optionshQuld h~ve a. F'eDlliWill just ~li.g.,'ltt.1y: great.;:::!:" t.ha.t'i

..

the· tim.e nowandt~ ;> t i. S the e~":'.:ratioIii. t ±me.. _!I.,n Inve st.or ,..rho

buys .00 cO'Iim10n andTNTi tes one $"J!.lch op1;,ion (.ad,ju:l:fting· th'e hedge as necessa-ry) ga1.r!Ls the rislles::!rat.,e on 'his ll€t irrv"Elst.me:r:rt or

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c e:lq) r'" "ij;~,,,.,. •

·Themark.et o.f'te_ I. :ilids,pr.:'ces I' such opti.ons .

I:f

the !It"€tI!l.ii:iiJim is too large (as it oe c:a~,io!MU!y is) " the i nve st.o~u.s es the preceding hedge to Lock in .a riskless rat,e in exc eas of that gene'rally .a,y,adlabJLe."

More frequently., the prlemJ.um is t·na small. to use! the .conmon stock :s00rt sel.e proce,eds

Then f1rnswno are able

b elaN' the r i. skle's s rate by s el_ingj 10. C:Om!!roD and buying one call. .. Or ~ ~y i:n(vl!l!sto;t' ~,.,rho, ;rant s to purcaase tae st.ock can substitute the o'p,t.i.on.... Then he has i:n e!'f,ec~ purchased "Che stock plu.s the risJUess excesa rE'litill"TII. hedge. If' the option pr.emi wn is belo'W' the fonruJ.s. pric e by more than th.e exceas "'"Jl."&u:~m.ct1oIliS costs (if any), tbJeDi, he MS a.dded a net exceas l'iskll!!'Ss n~t,i1Jr"n. to. his portt'oli.Q.

No,te: This e.xa.mp.le is me·aot to i! 1l!lStrate how the option m.odel can be' li1onm.a.~i ve and. be a tool fo!" !?!-"o ":'.d.ing exceas return.s ~ even thol.lg.h act.ua'l. market prices dil'fe!" su- stan. .~a:.L-y and sy~tem~tic-. ally f1:cm mode.L PIr' ices. Hor"re"ner'~, there ar-e other C ens idera t i OTIS {e.g. Lnceme taxes; see Thorp [28], Sch:o_~s [2SJ) aswel_ as Gfth!l!ir option modelsl, which sing:ly or join.tly cow.d eliminate much

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We ~ll -lOe cone e.rned oe1:ow :medlli.y "of-ith. t11·o: use, of st. ock yola.-till toy in. oytions model.s. However f .. ~ first Clisc'uss 1:mJCEll't.ai.tlties in r.~ bet'orl~ putting them as i.d€! .

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The, ap!'IToopriarte n riskl.es s M rat e' .is that on d~bt whi e hma t "UIT'les. Q'IJ! the option ,expi.ration d.ate [M.erion. 21. J • Un.certa.inty in this ra;ij;e

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arislel;s :first from. the :fact "that the:r~ is a rate r 1 e.twhich TI!lOne'y C2ill. De lent bytbe inv.e·:s.to!" ,. and a@e:Ol~rall,y different (g)!;'eater)

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if e.:!..th1er, iSOSIppropriate? T"n.e call. ... "'l"iter can get. t.he l"i.skl.ess r-ec&urn r by buying stock. lnng and continuously and . .appropria:tely a-d,j u.sti.ng the ratio oi' calls to 5tOIC~. It: can be s·hown "tha.t he

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for him r

buy,e.!' csa al so use the soo,rt sa:le PJr'Oc eed.:s from the 3t.O ck ~ e .. g .. a. m,ember !~lrm .ri t.h len.dabl.~ ::;t,ock)., the buyer is a. n'elt borrower' and should borrow at option Blod.el I"-a;.t e r ~ rZ . Now the f' ol"lD,uJ..epr'l c e f'o.rthe call. option iru:::reases as 1" Lncr-eases.. Ther-ef'ol!;'e it'

( .-.

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l"'z >r-1 ~then. in the abaenee of' "tra.n.sBictions costs, the, ~del )91':1c1;: ~t which call optio.ns shoUld be llOught l.S gl'eater "than the price .;:!lit whi.ch th~y ~hau1d. be Ti;~ht..~ .. ,

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not prevai.l.. Most in1fe~t·an; raf!Ci"E! ii.igni.f'ican.t tran.SS,rCt.iOIlS. costiil. The call option market price r'equired. to ];Jlt"ovid@ a giYen bcn'raw-

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co st s ia,c:!"ei;l,s,e:. Simil arly to p:rovi cie: ,S! given .lending rO\\ t e r 1 to the (hE:d,~ed) c,ail· opt,i,on T,iIT'ft~r ..th.e m~ntket pr'ic'e' of' t,he. call option ImJ;Sit; i ncr'e!a~e as trans,s!'ctiom:;, coatis iu.creas@. Thu;;:: ~ even th.o'ugh

1" 2.:;>' !"! ~ if tra;nsactions, ccst.ser e su.:ffi.'ierrtly high th.~ form.uJ.a'l s market pric~ for the buyer wi1.l be less, t:ba.n that :for the sel.l,er

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Ev"ell;,flt;h S'1!.Lf':tic:Lently low tr8.!l5Hc:tiom;. ccst.s (negotiated comm'l S,si,OIlS !, Or "be:t"te'r y,et, memhe:r f'irms,~d. ~1.O',o.r tra.Qp...J:."s far their Q",ij1l aceount.s) VO_~' T.lli.~~ 1 he imi ted by margitl, re~a"'ioJ!j[s f'o1." c"UstomersaJ.nd., net ca,pi tal r"equi.rement 5 and "hail"cut; 5 I' ['or mF-..mIbe:r SA,. applied t a the L::" finite avai.lab,l,e c.apital. jUso~the optIons t.rading a'f' many ':'ns't':'tu' ':ona.l investors is limited by 8. valt"':ety at' regul.ati.ons.

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To find! the ~ppropri,ate r for ,eal.c:ul..a.t'ing thle cal~ p.!'i.ce ~ Wle' are rest3:."'':cting con;:;oider,ation to lI'ris'kless,11 OSJ:ll6 w'he; en mature ;;.then the cpe i.on expi:res. EYen so ~ th;e:re' is iil.Ot. a. single r! or a s.ingle rZo ':::':"e l""rlder can~f'or instanc'~j gener~y ChQ09,e', among ot.her-s, from l:-bills, cOlmllercialpaper.~ short term. ,gove:rn:ment. agencY' 19<aper"

CD s a.nd. repo agr eement S • These rat es gei!:!,erally di i'f er •

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and

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- 2 • ~.LJle:lil '" ,1 = r!;

epen 'I on o;he in 'res tor f is

1'"2'

tax $~tua.ti,on. Th,ese vaJ.ueswil.l. vary -;i elY from investor to investor ;.;ef'll d ;ri L. vary for . the s arne inv,esl; or from OI!l.~ tax year to anotner.,

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l'here is ::-,easOn to be.lieve that the usual ("oe::t~'oI"'= tax:. nominal) -ina.ic:a.tOJt"5 01: !" a,r'e too Low , E..l,<!'ckpo,i.nts out that the C,A.."PM applied to obseeved ri sky rat.es iIDpl.ies a. substantially larger r. He S'ugge~r~s tha.~ a .larger .r' may be cor~ect ~md. tl"i.;at lenders !!lia:Y

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t bat C01.W:t s .,

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:;o~ !;l4ricev.el7 littl~ ::'o.r au:;;: of ':~be l7!'!:i:rrey opt il,':;r~s ,. "r::ooe~ate!yri !,,,It' opt.io:lJJ.s aro1lmd the iiltrike: plri.ce.~ Md most for dee'P in the ~nley

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options.

T:ben he· C:::e.!l - virt uall.:"r 1Fi:lock d~scr'i.bea ...

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LlPa"t=t.~p1;g,c'e'~ If 50 I 140"00'\" does one explain ~b.~ ex:i.sten.c'!'~lpersi ste!lce oi'~hese· inefi'icienc:ie5? I::h' ~!.i ";.he!:W:d,e\l ::;ris,s,PE!ci.I'ied.. a.iE:.c.. ;i,:;

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~:!le:!"= e.. r~e:tio~) :ode! .r"-i'~~ ,ll:!.i"'" =-::'Cgn"t17 ri1!dUCII!s !h~-""-~k~t.~ ~el ?!"'ice iiii=!·~e!!ces~~. ~~s :"li:g!::l::l?1

2:4.0

stock p.4'icle decn!'ese;s ,re_8,tivel toot-be :s:t.:;rik,e price" unc e._~,e;,inties in. the V'D,latil.i ty have an increasiIllg.ty doru,na.m; e:ffec-t on the ,cal'c:u.!a:teci call prices., Thus, for the pl"a,eticel profit seeker,

it: appears that 1Illl!cert.a.inties in v are of'great,8'r concern tha.n. those in r.,

--( .... F) ...... NL" ('d ) - C,'" exp ["'!:"(i,-,_ .. ,"f::,)',,] N("d_','2" ),'

W",A, '-', - """,,' " '1 ' ~"....=, - _,

(1)

" .. here' x is steck. price', c istli1!e ea.l.L ,exer'cise price, Til is the caw.. price ~r :is !TthelT r':skl,ess :r:ate" and

d1,2,>

"

- [tn(x/c)

+ (r

c2,?)

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In d,efl"i.'l'ing 'the formllila" the stoc.k p:it'~:-,c:le, is assUiilJed to he a sta:tione.ry geQm~tric Brownian motion (Le.the' l~QTrr!B.l IJ![oGe.1). L e. for an;y t andtz" -j'j_ !;htI < t:2;'~ 109(X( t2; ) lxC'" J] is H( 11 ~ (2) (no~ly) distri,bute,d 'i«h~l"'e' !J~' m(t2~t 1) and 012 = v2(t:Ct1). It Stat ! onarit,yU ]t"ie:ferstothe assmnptiontlhat m aIld '.~ ax,e constants; called the driI""'- {or tr1e!l!lI.d) and. the' vol8,ti1it,y. SitIDc,e m does, nat appear i,r!!

the opt Lon formtU.a {one of its remarkable fea. ... ur-es} we are only

cone e'rnedrith t he eft ect of unc e_M a.irrt ie)s in 'If •

in. r i~, tJ.v = (aw/'J"!:) IJ.r and. in. "'I~.n!!$ of the' rel,a.tive change in

\of ~ i" i 5 tJ,r.,; Iw: ;; (drr..r tar) fl.r /w ~ .. h'er e -.. s.nd dW I dir come from

2':1

fo:rmu..!.8. (i ), A calcu2ation shQ".:fs

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h~iCe fJrw/'ar and hence ttL.. (to good approximation, for sma.ll .6r·) :5 .8.!lI. inc:r,!;,e,.sill{il: :funct.l·on of::!;:,. coas,istent .nth our ·eaI".li~ qualitative discussion.

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On the o"tnel" !fiend. ~ l!w;' (3'ril' I (W') 6v f'or ~ll changes in V , ~J1i.th

the ,ather vax :e.blA:!s held f' ':'x·ed~ s:ing ( .1 ) again gives.

r -.

f

f

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'0 w/av :. ./t,*:t.' c exp(r( t-.'C*)) N'" (d:2)

~ Jt*-t c exp(r(t-t*»)exp(-d~/2)(2rr)-% ~

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'This is greatest when d2 ~ 0) x ;: C exp [ (1f212-r)( t.*~t)] Oil"

'il'lrl.c:h is equivalent to'

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x. :;: c. Thus yolati.l":'ty changes

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cause the greatest changes in tb:eformula option price for option~: around tbe' st.rike price. !t :lflli.---therr tllims out tb.e.:t the g;t'eate~t l",ela. ti v·e change, gi'ven aPl1rox"imat e.J_Jl' by

"',end.s to OCC1ll' around th.e str."_k,e pr':'_c:le or ~omeYb.a.t bELOW i.t (out 0:: the money).

'_0 esti~te v in the mode_, we f'll"st assume -[,·or simplicity -'-Mt the <!:rift param.eter m ea o. Lat.,t:x we' r.o!l,l remove this. e.5~.Ui:JJ.pt.io:!:l. _':"'e:n if y{t):: ~n X{t)~

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wlt!.e.r e 6. • t = t ~ 1 - t" and the Z. are nonma,lly ( 0 ~ 1 ) di stri buted

1 1+1 1

and. independent;, i:: 0,1,., ~ ~ ., , n-L, We .. -;is.b, to estimate - 1(2, tl"c'm

t.b.~ obse:r-rmtions (y(t_"): i ;- 01, .,~ -,nl.

].,

an.d

2

-- v ,a.,t

l,

f'or ... he' :sta:tistic

n.( . "2 i~l illY J '.

- w2ft -t )

-.In!. 0

l!,;t:t, -to

n 00

of

2

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1 ,~( ...• ~, • y) 2 .. '1/2 ~ ~,,2 E Z? ,6 '" t. - '112

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1.,=1

2 2 Q,.,t

= V ('.6 Z'I-

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- -)

2 6,,, t

=v~ L( Zi - 1) ,~~

n

- v.2 L (,Z?

"', ,l

1:=.Jb,

1)

p.

J.

e ,...~LUd '::"ike to Ifminil!liz,e 11 the errol' (il!! some sense) and the quest.Lon arises as to TOthether these 'w:~l:ight,.s: are Oipt,~l. If the Pi ~re Viery'

n (' J

' ,~ "T 'II

unequal the di,stribntion G,r i!l Zi --. P:i 1'trill not be 'fery 'tight

and t,ne es:ti~te ~.dll. 'be poor , In:tmt':OIn sugge::rt.s that equa1...,eis'hts. ~

L, e" D " ~ ._/n..) T;N'ould be "bese , 'II -1

errol' ~i ,. e. r.;hich give the IiJ.O~,t. e,ff'icient. es,t.imator. Tnenwe seek {TI. 1 .r,!:!ic:h mi~imi ze

~l

f(Pl'

E(Z?-l) :: 0 . A.

and

--~

.

l

n2 ( ·2 ' .. 2)" -

f (P,'l," • ~ • , Pn):: I:: p"E(Zl._", ... l).' , .. '-~ll ' J.

l. _

'l~ ( .. : Z2) , 1.[

~.i:.iill .,. [iii.' T· '-=

1.

r

L

"".lio... "~' t""'''' - '""_ ,,,.T ... +-e - .::;:" 0 "l"... ~ " I'l"l.o_, I.... .. .. o~ .. l· l"'::';::_....... : .,.,.." ,_' •.. - -,-.'"'"_ "

"' ...... Jec~ \,,0 ".::.II.;,,' OIl.-;I ""'.ii........ !?~ _. '", '" :~.i ~~. ':":..1"",'" .. ~- ....... , -

i,5p~ ""lIt!.

,&.,1; :I..

I 'L_

( .. ' .2;

. ~iY) ,··t:!it- ...

.2

_ 'il2

(5)

SO :E2

f -

": h1~ h~s :cln im'W'llL 'T,ra~i~n,c ei:!:l. tb~ c':' u s of ~$'t t~a: .. c;n:"s q f~y:pe EQ'" .. ~ o..o~5 Gl, c'om~~e to fl,'.:' .;.t.~ :-&'tio

~ ..

1

But

L (Pi, - ~)2 = ~ pi n L (Pi ~, ,~)2 - 1 -i-'!lv,az{P)

",

\

1 +-

. t

!1 "lU" (p) .~ 260[(1/J6 -112601'2. .;. {jI364-1126o) 2]: - "00',3130

.. 1/0

"_

1

I .__.I

.~ ('5) .~Q ( 6 L 12 ,= ( y2/:iilJ:.2 ;;h~e X2.:s. ~ {;]:!'i sq~e' .. '"'i ~hil!

liilegre~s 0:: ~1:"2~O~. Oe.:lc1ill,e.t5.Q~5, ,i$~V';:;~-;: a. 9~ c:cat1d.~:2'C'~ inr.:e:. ~ ~

=ar o:<i:e yC'2:r f ,5 (eliliU!U1y s:p~:~J 7~:eek::7 ,:;; .. -t;~ '52 i.ie,gl"ees of' fl:'ee40l:lJ is g;iwen by

J'.- -

~

t ....

i I

\ - . ...:.

,86 ~- ~v ~ l.2.0 r;;

(8)

Ii' t.bJe it~ar i s diilid~d int.o 250 aqlll}:! 1 t Ul:e int ervals "by oOserV'.at.:ions; (an &im)]"QxiIDat ion to daily data) th.€! eOrre spon.di_ng 90%c on:fiae.o.c~·

r---~

~ ,

..._ ._.

(~ I

L_._."

r

j

l _ ...

r-, -,

i ..

L_

ax·~ norma.l.l,y ( O.~.l ) di ;;st.ri but ~d 2nd. indel!?~nc:1ent~. i = 0 ,I. " ~ •• ~ n~J. • Corre!spand:ing to ( 6 J ~ w,e obta.:in

r .• -

, J ,

\ __ .

1 ~,.'i', (,., ••••. 6 i y. ~m, A"., i t ,.)',',1 , :2 _. ')

~J~' L; - v":

n i~( JAie J

( 2/., _ .) 2. , .• V ,,'n,·. X'

tlh.i:s Case 2 ~which appe.arstOI rrr'ovid,e little "toot is, dif:fere-nt from.

its par''t ic:1U!lSlr subc 8.5·e ) C-a"r,:; e I ~ i IS tMt.:i t :s.ao'Ws.( a ). "that. the value

of' !iii!. ~.s l.it t.l e e:ri"~ct, onttle ,e!St.~t ea value of V' and, ("b ) it :g;ugges"t.sto us how t.o est mateV~iiI'1t!.eD. ~i s tliLliknown (Ca.se 3 ~ lb elioioi ).

( _ j

\

E(~)

1 [I.. 2

r: m" ~.t

n 1.

1",,1

(10)

[ ,&.,t- r. l.

a

l:1 /'ffJ •.

~!rOl\icn:ian !iJ;Q1fiion ,:",b,1eh tn~ ~toc:k p:r:l.~e· x( t.) 15 assumed to follow) .. re d.efine R -by

The Fi sher and Lor i,e ·worK. :l.nd1cS! t e is a 1.o:l:'!g te1'm a ¥'erase val ue of

about 10.083 .r·o}!.'" .fa. OQI6.erved. V v.gl_ues. 0;1" s'!!:ock5un.derlyi.ng listed!

Ci~iGia~ he."~e g~er~lly 1:le!2J:lDl"2.C !tet ed "±; ~ii1'c eti. 0 .• :2: and 0 ~ 1 'vi t.h.th~ J::.~~.~. ;::es.:r o. 35 ~ Us:!q']J: = o. 083 ~ t.]:r.,; .,.. ..a.u.es c~r!'es1,)Oi!ai!!s: -;;c v ~ 0.2, J,~35 and. 0.. I"'esp,~1Ci;we.:::r arc~ O. a63.~ 0 •. 022, eaat -ij •. .:6~~ ": ;:e~~' ~~~~5 ~e' 0 .• 00 0, o~ 0005 ~ .e.u.~ 0., .)262" fU!dthe eO~leSPOl1!.a"~ ~ ¥a!. u.e is are Q •. OkOO " 0.1225., end 0" h.gOO .. The Pe!"C: ~ po d t i V'li! bias,.. lQOm2/nv2 ~ .f:rom n~gl'!liN:::t:LlJgm in the est~t~ of' ¥ :1.s

$ho1f.iil11l in Talbl.e 1.. :NOt e that tb.e bh.5, Ls "1'er'7/ £'):i'i];gll ..

One ~~ec:.'ts ~i:sk; e~' (M,!!nerv) st:OCks':.o ~~'I1oe m.gnermean. compo1i;.Wd! ret.1L.~S ~ •. ~'::1i l~ad:stQ le S!; eJtt~...-.. 7e..l ':,;,e 5 ;'Qt'. "':.he "!;;lias. Tahl~1 a

TiI2 sn::s;-pet:;;. ~ha.t. ~s't. 'use:=-s oi'tohe B.b.ck-iSc:!:loles !'o.~ use so!ili.e \j,iei~hted ·"el!:':;;;·1o.~ Qf '12 ~ D.egl'~C::It.ing ;~ .~ oct.ai:ning ",,2 valiiJ.~:i th.at u'e slightly too b.l'ge. The errrQr~,tnu.s int.roduced! a.pp~ar negligible. We sh~ll, th>t:lY1ef'ore, omit iiiS:Cl1SiSion of 'fbe Sictual

si :.~tiO!l, Case 3·; :;:ueantmknowu;1 since ~~e l~ppei~~ to a.pprOT-; m~te :."': '7~~ • .. e:J.~deed .•

,..:.;, "

l

T~.l.

r .

lai,a.:sm2/v'l ·b!.:;OO !:srt~,..,"'te Qf ",,2 "'h~J::!I. ~

:'.:,~ .:Is~""'!i 'to be:Z~o~ ~U~ 0.,08] "" a .:: .~ "l-. v2/2 'to Es:t:kat~ !:

T •

",2 l' m.2./v2 -:2/50,,2
v m m- En. -_'.
0 20 0 " 00 0630 0040 10 0% 0 2%
,. ~ ~ • ~ ~
0 35 1,2,25 - 2_7 0005 Q ~4~ 0 ' Q!'
~ ;iii. ~ j!' .. ~
0 1 " 900 ,_ :1.6 .2,0 ~ 0.26 2, ~ ~ 3~, 0 1%
~ ~ ., - ~ • ~.-

; -

r-

----.,

Bia.sm·2./",2. UlLI.dea:: the ~ed.~!!i~tion.s

R ~ 0.06 if "01 = 0.20, Ei:= Q .•. ~.2 :1:' tj'= 0 .• 10

.
'} _2 , . :2 :m.2/50v2
v ·v·_· :m. !W. m~/v'
0 20 0400 0400 0015, , O~ O~ 1.:
•. ~ • ~ I~;'I! ,Q
.• , as !!!!I .12.25 ~ 0217 .~ 0005 •. .l.!.l, 0 • 0%
0 .. 7'0 "'.9'00 ~. o· 12.S0 '. 0156 J • .2%, 0 • l~ ,-.

,

\ ......

82

IJ ~ m/ nand. .0:2 = y2.1n ~ Lett.ing

1 n l' --'-"):2:

=, -., 1 ... 11 Ill. Y ~ t!.·i'Y' '~,

ll~ ].~ ~ J.' .

is ;(2 (n-l ) d::lLs,'tl'ibuted. No""~

t·..., j

I

\,_

so we can use thi s st.at.:!. Sit i.e to g~t; c oniider.!'C ,e int eI'va.ls for 1I! is 1!illltnoY'U a:ad al.l .A .. t - lIn.

J.

'. {l~ h~v t .•

.",2: • such!:l.s e2 in. ca.se

h (~ ) will in ge.iLIleral rfu p~icu1,a.r ~ Ls $ biase:a

!i!Il "" 0 .•

estimator of' /VZ = v.) Tllw,~ c:otls.jdering w(x~ t) :f.'1'Om.~q~tio\il (1) as a fllilc:t ion h( 1[2) ~, h (£2 ) i.s !jJt~!.y to "b ee. biased ·s st :i.r!m:tm." oi: h(v2).

L __ ,:

It. s,ee;m,s desir.able to use the date, b(t.): i=O~··· ~.oJ i,!l!sucb., ~

1.

1i!l'aY ,es: t.o aot;.air!! an unbias·ed e'st:i:rrIate! OKW(X"t}. L~t \of C~ such

a!:I:un~,iased esti!nator Cl,t' w{x~ t)., _ Thel!Jl. E:(W) "" w(x ~ t) i.sthe oyti:oo, ft~,rTI!l.l!.la value ~~ ( x ~. t .~ 'If }fot" 'th~true! (bntwllmO'W'll ) v' . I h.a. woe !!lot finis,he·dthlilll;,ing abo·ut tlhi5 :~Mt'oblem out. a. choiclet'·or Til wlricJlJ. se,~. plans i'ibl.e to me is:

{ . ~

I ' I.

r=>

r

...... --

1 n ,.,

"WI = L '.':Cl·w(x:~. c, (A".c y)4./ Q~,'. t)

n 3..;:::: .......

h,I}

r ,

,

(" - I \._

!

~-.:.-- ...

..

250

It' (11) is appropriate,. howworud the ca.1c:u.lat,ed !!!Od.~·l pr'ic~s chang ·e? The numbers· w ( x, t) . .ill (2) aI"e a.n.a. vera,ge 0 t ~{x ~ t , \I'~ )

. ]I.

ve.1u€:s: for ~ renaiua- oYer value·s bot.h aboQ!VI~' and below the

i 0 0:;

?~:l n 2.' .. '

~ - ~ .&1..('.,1) fA •. t.

n.:!L~ 1. 1.

is. iner eas 1ng in

and.

E;qle.rielilCe!ioo"ith the· formulasuggest"s th&. v·b::,.t) :;,. w(x~ t) in. the regi.ons of in,"""erest and that the most, sign::f'lcant Incr-ease in the

C =: _00,

·=v2 n.-.

v,2; : ,.1.

,,2 :: n w2."

U.

T/il'('" t v2,) _,

. ,A;.:" ·;1 i

.,

t*~t. = .5~

x = 200~

:~ 0

and

-,.05 100 e

2:00

Then

(. 2) .. - .05 .JL 1'"', ·0'.· :":.' -.0,/",.

V x t.v < 200 - 100 e ~ ~ ~ ~

. ,.." -

.,. ';)_'·00 - . o· 0 (,'>._" 0'5 < T.~(...- .<,- '1 .. -2:),

_... • ~. . .. "'" ~ 1,; •. ;

hence f'or suf'f'icien.tly le.rg,e

n ~ <w \

',. __ 4 ).

"This, is a.!.s.oa !"':;gi·on where th~ mode]. 1'1:e.lueSaIl!:! g:e:D:'erally :signi.f'icantly beeleR tllie,rket; prices. Hence removing the b:a.s 1.n ,.". may l"emoye much

01" all oI't.hls difference.

'iil'e hope to teind out whethe:rW Is unbiased folr' W and , if' sc , wi I. cal.cukabe mode_ prices. wand. W' for ~ ~mria'ty of ~,itU:::lltions, to iove:st;iga:t,~ ~;ijhether \iii" is signif'icant];y greater than w.

Here is, amet.hod ,i;Thich coukd te:ll us to, wba:t extent the calcllJ..:=.ted m.od.~,.l va.!it;l!e ot' w, based. on au estimated.. v, ditf'ers from the tI'U,e mQd~_r~ue,be5ed on the true v , ~I.ssume .::"or simpli'Ci ty tha.t m: 0, w-hich is Case 1 cd' section .~., 'Then the dat.e.~bE!.sed, .;st1m.at,or

is Chi-square with

n aegr,ees of: f'reedcDil. Ol'd:i:naxily Ute ODS,l]!!l"Ved. 1falu~ of' e2 is :su-bs'ti "'"u:tedf1' v2 in the Black,-Sc.no.les, !~ormu1'!l ~ g.iving an option

... ',c> .. \

. """2 i •

.--.,

r ~.

251.

fi'Q""" l!e't :: (,e2. )1b.~: t~.ep:rciilab!_! ~J .!ens,::: -;r;~'f ~~.'~ ion :''o:l:'' ~2 ~ · .. hi e:!:l .. -,e: ]101le'l1, 1.9X2 (::il) • !'he'I!!

_-

is the ,e'JtP~cta.t1on Qf' 'the ce1c:u1ate& :t:!lQdill va.lu.e of'w~, li~sed on

'~.'" eiS,"t~t=~lfrom UlJe d.s.t~,. TIi:~ can c,e.1c:ula:teE(W(,'z)) ~.d, .. (v2)

::-~I' ~io~~ t;~y and ~S:1.i!:::i~ :' • ,:,"",~:s can ''Ce eLl!'T::!.,~d., Ol:.i.-!

I

,

',_

e2, as .Lseu~t.oJ:JJ.ary~ W'o,uld @:lv"1!; opti,o;n model pr::i,c!Ss which are' bi&s,ed, d.oTfli14w"8.!"d, e:;;pee l{ll11yfo.r C)1J,:'t of the m.ousy opti,ons, {as, se:em5 to be the' C§SE').

I

l _

r

:1l.eJre :is a~~idly" 'expSJ:~~ l!-:,;~';1ll:'e' O!l O]It~O:llS, ,~l.~ ~-:~~s:~e ~a:h!! 3.!..aJ.ek~ho.1es, iaOdel (i:;ee~!!<f'er~cecs) ,. :t l.s not yet .kmrrn

I

'.

;

l.

ei t.hel" inIDf!k"i ng pred .. ieti.oi'ps o:f~k,et p:rices .or as t.Qols :tOl" securing e:xcess rate!l of r'etU1t"U.

{ -

;;:!l;,'Z! ~-: ex!st5~' 'I.i,2 = J.i::. ~{{ hi 'l.1_'~ ~ ~ .~ ={K:) ~ -d ~l! T '::!~:llst~~A~.;{l

]"01'; e -:ha ~ 'IJ ~:r d.epe:ld cm. x Du~ Z!o~ .0:1 I:; • ?Ol" t he Jl,:_B.C:'il!::_;:;c~: es

_,-

\ ..

t.o be :e. CJr'O:SS,~ is,ecti anal. as.s ert.:icm • E~I!ce~, even i.f thelia v~ra.ge t!

C! ~--e;r'~ 112. the '~i fOT val'i,QU:S st:ocksm'i ghtd.if'f"er s:.ig:oii"icatltly

from. 1/'2, .

. ,,,,,"s "" po$s,:i1b~e exp~aaa.tioll.) cOl4sirie:rthe v:a:rio1!lSpla.u.sibi.li ty aJ!:'~::::l.t.~, for the .lognormal de;;:;cript:ion Qif' stock pi'ice:5. 'These

&4'grnn.em:ts 5e~. ~til1 more plausibl,; .. ben appl.ie:O.. to the t,otal

assets (d.e.}:)';E; + e'lquity) of the ca~. S:u~:i5e then that the pY'ic!'!l of: t<b.e total assets of a COUl]PMY folloliii's the IJogJ:;lormal mod,el.· TII1le:t model. d.escribe3 t.hepri.c~ oenayioI" of' the CO!llmon :~tock? The follow-

ing ,e:rnnp.l.,e s.upport s the idea t.oot

ima t~ly c orr ect . rode· overs.implj. f"J" to ill us,tra tie thJe jpoint; mMY of: the restri.ct ions can be .li i't,~ d.

L'rn'Iegil!4f1 a ciGmp8JITywhich has COImlID:!JL st.ock end. a single bond Lssue ~

wi..th. IDlooth~r d,ebt (e!Y,el1l. bank. Loana] 01 any .kind.. To sim.plify the

eam'"i ne; llse of' the B18!ck-Sch.ol~s mo,u,e:i, a.s·smne i'u..'Y"1tlb.er that the stock. P&y.s no di vidend.$ and the bond has 00 co,upo<I! (tooemore ne\~H.ly reciistic~, t.t!:ink O!~ it as, having been .i $:s.u~. at an appropriate discoun't).

Su;prpO$e t:ha,"t ]both s:t ock and beads ar'lli! continuQuJS,ly and a.ct i vely t;.;rad.ed on ~ e1(ch.a;.'1ge sc 'liie he;",,,; tb.eu.s~l p'rie e in! Or:rJ!l.a ti on. Let

b (t ) be th~ maG:'ket p;r;i.ee of' the eitli,th·'~OO:II.d. issue~ T,i,T( t ) the ~~:rklet 9ric~ of: a.11. the stock, an.dl c thef.$lce~"t of the entire bond is,su!e.

Elric~ of the total ·e\$;s·et S o.r the COOI;pa.n:y. Call e.. cl~.!m On the total assets i!s;uper"st.ock. 1'E If we think ot:s:toc.k ana bonds as iii vi,61ed into

r _, j

r--'

l

'i~ __

r

l

I_._ ...

l __ .

r ~ L._

L.

r I

\

253

s:upe:I"stoc.k ~ hen the :!llal"ket pr.i.c,@s of' stock and bonds give an e,:ffec:ti ve roru::"ket pric ef'or $u:p~:l'snru.-es. Note that.'t:./N, 'rtll_ :a.:nd -b/L are marg:i.nal prices: -wre can buy' small quantities at these price's but C' we try to buy' a whole Lsaue ~ o:r the whole company;

b,

or

x, 'Thus r'mark;,et price" for an is,sue here means (p:r.ice/share) x (no. of snares), rather tha!p whe:t i t:i'iI'OulCi a.ctuallycmrt to buy the iss1Lle ,',

"'0 :;oed,eem the bonds if' the CCl~ aSiSets have market price gre:ater than c , L, EI' • H' X {t *} > c, upon redempt i on t he stock Ls sue shcuJ.d have ,market pric e w( t*} ~ xlt*) - c. Iff Lnat ead x (t*) a c .s.:t ~,*, tbt~ stoc:kholdlers should let their option to redeem the bOD..ds, e~ire

1.l..lf1eiXHrcised. '!hIe' comp8.!:l,¥ de:fa.lllts: and. r,o( t *} : o.

-.t i'oll,o,,"""S tn.,en that in this, ~,:Ump_ijfiedl example the as,sumpti na 01 1;he B~ack-Scho_es option mod.'e:1. are n.1l.:i .1.ed. '1'he $,tock is a (E!:l.r ) call opt.i on on the sup ez s to c~k r~-j_ th exer-c i $< e pr i eel' c and e!xpirat:io;a

(The id~a. up to -his point appears ':'11. Black and Scholes

6]..

Se,e ~i:th [26], §,7.1 ~ for a co~act. aeeounc i ) Using the ooltat i 0'0, a.nd :uetficdoJ.ogj'" of the appendrx "lii'e, have

hence t.he ratio of th.e rela.tive' cbaage in equity of: the stock to "'he ::mpel"stock is

(WI v"" x. Z .,/'IT + 0 (.c. t) ] I'w [v X z J4.t + O(~t:)]/x

W1X 'iii

are tbe re~pecti.ve "'lognorn.al variances. I~ Suppose now that '1i\oT1x/T-i[ ,_ W '-Y, 0 '" y <1., The'.n

ft.'here a: ."". l - 'Y) 0 <: a< .1,~ a.ndw di,f'f'ases ac C Q,rding to a COlx-11os::" [ 9 ], "con st.arrt ~last i city of -.;farianc e irl madel .•

. 1

.K, + 0.

is a iunc:tioo.

. I

.1ogD.0iJr'ill'ii& i .i ty &r!.d th,e Black ... Seholes m.ode:! ~ b::)"".l and the q%nti ~y 1 - CI. bd i, S M i ndi c a. tiol}: ot' the ext eu:t o:f deviation, of' th,'S st ock MO@el r-::-om .l:ognormelity. Taking log!9.Titbms., a:.(x) = .log (wix ) flog roil.,

~ -00

Figure 1. is B computer plot of c:.(;;c) v!!J,eilt~ - t = 10 year$~

v .'" O. 3:" r Q. 08 , and c - 1. The Cllr-'lTe ;;,;,a,s, a:r:ai."p,byo alcula t :ing

(Zn. w{x) , .~n (r.or1 x.) ) for x - .51 ( . oi) 5;. 50 :~.d plotting thIs param6i5Jt"'i cally de,scri b,ed (by x) ,crurV\!;!, joining sue e ;;s.$.i "'ifee,o!ll:putced pc i.n.t s . T"ne points :li~or int,eger values ox x ar-e !111~~ltedb-y' .1~bell,eQ. Cr05~H~('il. SUI1e:r'imp::>~,~d is a li.gll:tel' stra.!gb.t l.i:ae., "J::his i.s a. r~llest It l.in.eHr ii t 6st"ir.'!,$"teo. oly ~ye. Note toot i,t is, .~,remar.kab,q B)Ood fit over the ~nt.:i1.]:'ei !"ange of'theplot. Ttl,; $1.GP~ of' this, iine! is 6 .. 6tl'. TT "" o. 8~9 .. It Ls curious that it happens to coincid.e so 1~x;a;ctlY ~Tith the' 0.8'5; ea:rl:ie:r re~rted. The rem.ge of' x Va.111E:5 covered i$ frQIIJ. O •. 51. to

5 . .5 ~ a ratio of' super sscck prioes of more t~Il. 10. The range of

to

1 ... 6

~ .... ea e

of: mor-e tJh,an 24.,~ afar wider l:'Mg,e tbaLl~o:nll.aily enc aunt ered[ d.ur'i n.g the lLfe o.f ,e li"ted call option.

!"'"'" ""-_._-

r-. i

"" -

""0 o o 00

, I

j_

.' i ....

---I!

LI '.J\ I 1'.1 .... -L ..........

!---;,,-:--___'-;---'--t-i--'~-+' ...Lk,'.; i t t r r . i , f'~::;;.· +-r-l-+-i-';'-",...-..!...-~....:.,,:,,-.!....:'----...;.......j ;:::

I I, , ""-ii' , r'",' I , l , .._

, ! I , I . 'Y' I I I I J" I I , ~

r, ,-r .. r ~i ii, f"J ~

, ! ,; I 1'1>.1 I

I I I I

~'

I I _I

, i

~ I

, , I

J I

I 1

,

i • ~ I I ,"OJ" r-

I I'~ I

, I J

I : ;

-'- ' j, " I i I I I <'lr;> 'K ~

i I I I I i~<') " ~ ,

, j

I I

i '---

y • w

e. !'~.k:ah1.e l:inear f:i tover the entire ~~g)e~ The V·8l];t.V::5 of x plot;te,d. are .0·.·'51(.01);.21. Tb.eslcfje, i'il 0.766, the ratio of ~

T!l!!e F-e.plh g:i V'e:5 .for the 1.inear f'i t ~· .• 2314

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TJe al.SQ ~ .. ;? graphed the caaas t* - t - l:ire~ i~dl t.*.~ t '" 1 week. Tb.e~e ~e ~::;.hQT"'n i~ Figure·s 3.~ 4 and :5. T"n.e!'a!!,ge;m;d p!I:'E:ci S ian of

the 51llpelt' st.o~.k. or the' stock can ch~ng·e i~t]::!,e· t i!!l!,;: t" ~ t., al~o dec!'eIS.5.es as t~· - <:; iie:cr:ea.s~ s • Wble!] tor ~ is C oI!sidered.. there is a. ~.-te'!'Jl' good linear f:i te. bout each pain:.t {:ltD: f"( X), in ;;1X.) on the C1!ll'''1'e5.... Thise·xa.m:pl.~ could. iDe erlenc1ed! 'to c~'e's -rl.tb. seve.!'e.l cla~s:e$ of debt.

It J'ijTou.1d. na i.rJi.t~resting to see if there are i~l;!l:Jt cOlll~i.;$t;,·hich S!.pprOI);firnBtel,jI" f.i t the as s:urmptioiQs' , l:ist.ea. COliIliilOn. stock ~ one cl1,j!,.$$ of Ihte:(1 a,e"bt ~ S!;!;)'d no other securities or dents. Then t~e option ~del~ ow.rlL Toe ~$ ed a$ :in the exampl.·e ·to cal.cmle:te common. stock

'I'h.e ex.E~le~. $[1 !!rore ge'nerally the !!lode! Qit: :i:;:toc;k~ .~:~. o~·t io;ns en ~UFe2":;:;tQckiiiO ,. 5uggest!5 the principle toot Crn!:!l!l.on st.ecks should t-end to 'be molr'e volsti.le as the detl't-tc-equ:ity !'$.tio i.ncre.s.ses.. We can

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debt -to- eq~ ty rat i o and look for' a. pas.! t Lve c orr el.a:ti on. Ifhere bas been a IDaI:rked! secular increas,e in debt-t.CJ~e'qui't:1.for Amer'i,c~ cCirpora.t":OtLs in the po,$'t-iofar era. Ha.s there been a signii'icen:t ::iIlCrea.se in stock vola.ltili t. Le s,'!' Accol"d':ng to Kidd.~r ~ Peabody [l.'fj, .":'n. an inoteref5ting diseU5sio:iJI. or !i:l,~"\""ket. vo!atil.i ty~. there bas been. such ,~incre,a.se. They try various o.llle-variable explanations ~

i:asti tutione.lization of trading ~ 1nt'erest rate :f'1.uctuetions" and

a. t.rend (tu-related) t~ds, ~oweJt" d.ind.end pa.~,('o,uts ratios. ~!olli!e seems; satisfactory. We sugges,t, tbat they add a. new varia.hl.e~ a,e-bt.,to~ui.tyr8.tio ~ and that th.ey then use a multi,-l':uear regreg,sian on the who,le s;,et of va;ria.bl,es"

In shorter times (like a ye.e.:r) 'W!h:en tbe debt-to-equi,ty .ratio is detel:'.!!!tined mainly by:-~uctu8.:tiails il::l. 8,tock. prices. does the voLa-

dop ere entage c l'I..ange s in t he stock averages te:nd t,o be larger 'ii~hen prices, neve fallen, tha.nwhe:o~h~y ll~.ve risen? (Note,: Over lou,ger

.: er'iods. other factors a.a.y dominate ~f'fects of' price change on vO.JLa,t.i.:li.ty. . For instan.c e; oyer tIle po st~'wbrld Tda.:r- II years , stock p:r i.e e:s ha1t'e! risen ,g_l"e.!;.t.ly. This might "oe e.X!l8cted t,o l'led:uce stock rele;t.;i'/e vo.la:ti.l"':' ty. Hovever the debt-to-l!!:qui -y r,e,t t.o has also ri s en gre-a'tly' 'lid tJl the' ,e:efect o:f ra.ising Tml.a .. ti11"ies '. Th.e net ei'f'·ect seems, tOlbe

a s1gnH'i.cant incr ea.s e in volat il.i ties. )

~sraotiOin 01' rela:tive llo,l,a,t.i_.l,ty iD,creasing' as. stoc.k p.rio:,e·s de~r'~'l:u;,e' mB,y e'1ql,,1a.1n severe.l, plUzzl,e'$ in t.he l.it,er:E!.tID"B. ThoI1! and Kassoui' [29] report a regreSSion raode.L for-iiiarrant pr":'ces ~ de1,1sed by Kassoni'.. The

~d.e.l.is vbd = Cl+xz,)l/z ~JL wih-e.J:."e

ab,le s t.oot is det ermine·d by !' egre g,si.on on: data.

In pru-t i cu.lar 'z 1,s

f,ound.to 'be inc!'easing in xJi~ ,"""be:r'~ x is a. surrogate for the ev~age st.ocz pr1,ce Ov~r tn.,e' pre;;::'ed.1l1J!g:1ear. Sinc:e inclr'easi,ng z;

the regres:',;.ion. says that ii' t.he stock pr"ice bas,

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if "the: st.oek price 1'1;$.$. fallen ~ the' ffioGLel. p:l"ice is law,er.~ but hig;b.er than i.!' x/i .. ere not 60 s.ma.l._1 •.

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In te~, or th,E"l Black~Sehol~s mode:! :~. if stockprl.ce Til !nc1r·ea.s~s and "titevol,1!1.:t!J.it;y ·of w increa5.es, more slowly than w (as it does ",hen ii~ is aJJ!. optian on the sUDII~rs,tcc!l:.)" th~ ID.odlel price is l~ss -.;,h:an orth.~:r"I'!I"'i~,e e.xl?ected~ Converse'.!y,. i:f ·rwf:!3Q.ls, TN""€! expect the vol,a t :ili ty to lIe hignBir than p:rlerioillil,lyoe.li. ev·eii , t nus a higher

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m.odLeJ. !9!"!ce. My casual obse1;"V'art:io·~s d1Jll'i:~g is! d.ecade of trading wa.rraJl]t a and opt:[ ens andlo1at.ching their pI"i ee a~t :;[.on c oni'i l'ms 1:h1. s i:Jena¥im" .. .A. quan:ti.tert ive v'~rii'icrl iOUT;ijl!Jllld be d~s Lr <'ll ble.

Not,e $1.$0 tb.at this e·f:fect·: optian {and 'i,1:ID"!"ec..lIlt} prices lagging belor:w mode]!. m:ic Ie:;:. • .. hen tbe st ock.~.$ U];ll, :and legging a bove model pri.ces"iinen t.b!~ ;swck runs dorm. teo.ci.s to J";~lain.~' ~:t least part of' the two p!'ilJ.ci~s.l discrepE!!.nci~s which s·eem t,Q '!f:x:ist.bet~~e:n the

Blaek-8choles medeil. and IJilarketprices.,

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Leabo and. Rogal ski [:2 01 :t9POrl ed ths. t WaL:ran:t pri C e cbanges do

not $e~.tQ fo.llow the 1.og;n0l"Ill13.1 distr.Hm:tian • They conclude that

.. i,1c!.rJran:t lfric: e C Muges. are not coned ste'!!]t, 'irl t11 the I'alldom rj,1"·a.lk llro dJe.l •. (hJ~' a.naly's is: she .... s that it the lognorme1 !i2ooel h.olds for st ocks end if th~ Blaeit-Sc!'..ol·es model appl.ies ..th~]J!"""'e sbarud expect w:a.rrant price changeSilJl'9t to be l.ognorme.ll,y di.5trrtru:ted. A detailed analysis alm:llg these, lines l!!1E.y .exp.laiu ~~y th.e Lea.-oo,-lfi:ogQs.k::l. refilults and show "that war!'Mt p.~.i c 'e c;hMge~, ~ COD s i.~t,eIJit rrith the logn.o.rma.l mod!e;l i'Olt" stock p:1"ice changes,

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q1l!ckly detem.ine~tMs iD.t.~I"V&l to arbi tr~ p:reQi.~ion.. Thi s ilO.ter'tal.. i.$ e. c.o~fid~·DC e illt erval for B.

~~:i: ,=: _ "l:.:':Uedi ~Ii. .l.~

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:tor :'.:;lS1; o:::nce ~the x, a!lGl ~ . 1 ::6(1" one ~i c:ula:r' wee.k CD. the

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new' York S"",ockExchange.

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:... u.~ e Of~5t. ~;to~t ?l"i.C-E': 5a.:a '-:'0 tae~e.."":'Llli c e ViolOl:"ti:J.i;:.f ~ Opt.-i-mal1i!~igb~i~ (;:::_~ltlr ~e~ ve.!"51!lS mor·~T~e).

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2:.. .Be gres 8:101:1 to'Vards "the' ~ee.n.

.Mart-in [.18] tQ::: s: •

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Usi}lg op~i.Cli:! Y·olati!i:'3{to (help) !;o:recast '10 ls.t: i.:.i ty: ~!';&llEl! ruJd RencU.~ [1.9: ..

_~ lte...~"t;e opt.:'QD. _ooe:.~ ~

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:2.. PlOss·ible J!"O~!! O~::..O:'iS.e CO~:;:~rr;:; in. the: Sl:;oc:na.s;;;:ic pr'oces5 des~ribit!!g: $:~);;l:r!.ce. -Fel"nhol~ [12].

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~Y' change vi~ a randOJill f;'-aU,. BJ.l1c.k [~,,2].

'~Volume tim,e" versu.s calenda,r ·ti~e,.

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A C'()rr~cted- De!r':!'va'ti,on of the Black~Scb.o.le:s Option Idodel ..

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a:pon stocnasti.c c~lculu::; and It.C:' s lemrrh8'. Th:Ls demand.s 'mUch oJ' the :re~tler. Further:m.Ol!;'e the @er:iva:tion as gi1t~n contains s'om.e: ~tb.em_at:i-, c:ally inc orrectst eps • The rl~vi:!1i ed. dle'ri va.t:i (lawni ch. t..re g,i~.,e b.e~r~

ap:pears, to be mo:r~ r~early nw.;them,~:t:icall:f cQrJr'ect .~ intuitive', re,la.:'tively undlemanding of read.l~r ba:c.kgrO'Wl~" and,~'\a::y close in fo,~ to the o\ri,gi~a2.

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_~crtertiGl!1 ~ terminology, and. procooure :fo1.1ow Black a:nOl Scho.le~, [6] ~ pp. 641.-643 eq_ua:tioml (1)-(1).

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opt.ion,r:; s,old short. W,e intl'oli'Uce (il!!&1,l:!.c:it.ly) at thi,:;l l)oint the a.SSliJU:!lPtio:tl!tl'wit· there :if! a conti.nuou5 I'~smoott!'n (i. e. n~.u.f:fici.eillJ.tly m'8ny~1 cOnt:inous partial de;d.va:t.ive$)~ction .,iT(" , ,.) such tha"t the ".]'slue .of'

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To, ~ first· ,a!l'proximati.on.~the value of 'the hedged position does, n.ot depeIDJ.Q on the p:r1,oe of th.~ s~o~:k. '£'0 seethls,~:Xpe.nd tlw 1l:Y' Ta,y'lor f $iformrua:

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(,10,)

($,tQc~k price chang~~ are l(l<,gtlormaJ.ly dListr:'iJ:ru%,e;d) i ,., e. the:y foll.o'v,i'

a geomei:I"i.c ,Bro~.tnia.n. rt'!ot,]_ on with drift). Th.'e 'co:a~rt.,Mt, s m a.:ntt v are ea...lled 'U dri ft nand "ve la,t i,l,i,ty'~ re sp,ect;-i vel,y • The Z, r e'pre sent s ~ no~l.ly di:s;t~ibu:t'Bd random vari,abJLe ,""it~ zero aean ood \.mit variance. T1f:!; sas"i:jU!l:l.ption (lb) correspon.ds ~oBJLa.ck and Scholes I as,sWlJ:p-

tian (To). 'l"h!~ ,lS,]I1llc 01 0 (y) means t,ha:t ICH"'SOIDe: E:;:' 0 and M;:. 0

-10(1') I < Mlyl

o (Ci!lt )~J so

tllio.:t ~,~ :izy a (6 t; ).

It is the

i tT,i,J"C!.,S r!eq1!JLir~d,. No,t,e that ~ tbout Z " (1 b) 'l\i~ould flq,u.a t e the ran-dam VaJ:' ia.h1.e Ax to the C oI!8bmt m.'t:Ll t-'l- ~lX'~ '-ii" 0' ( 6 t » '. This ,1 s ev:1. dent!y

(Ie)

by ~";tll.x ~ t!,x 4i' 0 ( ll.t )

henclethe

change in, tb.~ eqtll,t;y 01"" the po.rtfolio is

o? apt io.n.srrill chang·e by O(li:t) ..

(2)

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NG~ for the crucial qorr'ection; .As:5uming the short position is c~g~i.;l continU,Gu5!Y, we havef.rom Taylor 'I si'Ql"T!l,'Itla 8!:nd. (l.b) appliedt.o !rig-per

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Notetha"t i .... th.e original d..eriva;t;iont:!lt;eZ2: :is missing at thi.spo.:!.i'1!t. Ei:e:nc'e tfi~ random variabl~ tl.~ is being incorrectly .eq~.t~d there to

a constant.. EM.ek Bn:G. Scnole s in !-:'a.ct C ontiul!l19 by saying: uSinc: ~ the r~t:w;n on the eq;uit:y in the bie-dg~d!po;si.tio!LJ,. is certain,. the ~~"iJrTI

(1 . 2. 2 ~,.

- ~11v x.

(x

'11

(6)

.Returning t-o (;;) we pr-oceed dlf'£'erE1l[ltly. Mot,e fi.rst tha:t the Z2 term. s,hor.;,;s that I:llEl is risliry. HO"Oi',;'It,er~. as the time ir:rt~rval.s beti'';.eeil! arlj us t!i!t~rrts in the h!edg.; ratio t.end to ~e.lto.~ ~ ... ze shall show that the riSk i:i::! a

-I

268

-'

JIo. ... - [. ~l\ c/ (';' 11).../ • _. '0 •• ,. - - 1

0.;, •. 1.. _, l~,'· ·n, • .J.."T"_. _"",. ~",. 1, -" ,n,-",

,1. _. , . .. - , .,

Let

. E be the change in equity cor:res,pon;i::!g to

.!l.t ]_

and nbte ~he.;t

- ~ (.· .. _,2l.' .. ", .. '.1' 1,·~'2.,..2.7 ?- " ).... t/

...... "" v ......... " T fN~? .;",~'. 'N1

-1 -~-

O(~t/n)3/2)

(6a)

where the- Z _ at" e independent ( I) ').1 ) !!lo!."'!W!.Ly disi;ri but ed random 4.

,,"ariab~ _ .es, 'rhenri t h n-st ep adjustment o,f'''':.J.e hedge,

n

... ·L;e:.Ei=l 1.

1 '2 2 ('1 n .?\. .

."",,,'. ~".-.y'.,=. ~... 'J - F iii t ;'w

"'l·"'·11"·"-" .• __ .... ; -·1

4 --' .n :l..= - Ji... .

(6tJ }

Atj' , «,II f..)3!Z)··/. cr:

- w . _. . ~.7 T ,~~_".... " in.

·2 ·"1 "oj

lim .CiE =

in proibab1li'ty ,.

Thus cont.inuoUE adjustment Of the hedge y:e .is, with probability 1~ for the ,small.""'init~ time 6t ~ th,e ri,skJ.ess, change in' equity of (6'b) .

. E.q_ua.t.'ing thi.s to (x - ¥o"'h~~l )r~t ),"ields eql..lial:tion (1) ,of' Black and Scholes~,

\ ,-

.~ .... .....,

r~

l _

,--

L~

f -: i

'L _

r=:

1 ~

~ .

.... _..r.

r - "

,

To preserve' the' intuitive' fl.ow ot;"".lle' ,ergmnent T,le have omi"-tedcerlai:n readily su~'pl.;:"ed but t.edious s."teps: Fi,rst ~ ~he expansions (la) ~ (111) ~ Lc):, (I:,.) ~ (:5), (6",) ~ (60)" enc, are! clorrect in some bounded r_egio.n

Io,x:li '0;;; 10; 1, ~ ~ at I <: Oz ~ but II ,tJ;X I :is, 1moounded. However ~ by choosing

sui'.f:i ci e:ntly' ,smell 0:2 eJ1dg;iv,en. 0 1 ,~ Pir ( i ,ax i ~ d 1 J can hemB.de,

as, ~. as we like+ Hence tbe' ~S.ion9 ,are cOrJi"ect except. on a s~ o,ferbi tra.rily smali ~o,ba bilLt.y. :Sec ondly, w'e should 00 serve tbat, the 'fay.lor e'xpansion (5') is va.LiCil uniform3.:y on a neighborhood o:t:l::,t.Ther'efol'le (6a) holds si:m!li.tarlleou.sl;y' (seme constant M for

o (Cdi t) 3/2)1) far aU_the fiiE. This is need,ed sow:e can vrite

o (( ,I!!;t ) 31 :2. J11 i£"' in ( 60 ) •

The d.e!"i'tra:tion shows the a.pproYil"late a:m.ount of risk from t.he hedg'2

it' ~he adj u:stm.eut is not c'ontinuous '.'

the (random VIll"'i<ib.le)

'rhen :from (5), ~ettiJrlg!'(X) be the' expectation of a .randt'....n1!.. Y<U"1,<'!~D1€! X. it follows that

E (R-r )at- E: Itt - E r at == ll,E ,-~tti,E)

- (~"1l v"x2[Z'_~~ ~t/v, + Qtl>t l 3/1

27

R ~ r -

- .

(10)

, 2,( wi x-w)

diSC""!:":ilYa:t:'O:il of .3, aoout themeanr ~eIlenaS :u:;oL':~nly on the .;oe=!.'~-

c::,;rr.: .3::;::; ~T;r,~ ~,~x212 (!i !:-v ) ~d~ ~:I!n' s::: ,~ :_ _ t: ~ ~'& :lUC b. on ...

+ r . 'W'

(d )x

-

-

..

Wi··t*

. I -

t; :_,(d2)

- -, K-- -

,

.~~ -'J

} .

L __ ,

r:

\ .

'l __ ~

.I' - -

\

L_: .... :

Note tha. t ~ neg_le·cting 0 (( tit ) r /2.) ,R: sat i sf:!. es a R } ~ r-, a2'(R) "" KZ ~f(Za ~.1)2.1' "':.' 2K2. )~d. ('since K < 0) ;R is:tIl the

int.en~ = <Fl -e it- K. A study o.f K viti ind.icat~ the r'lsk ir

di2 ""'-=..'rhls is correct and. can. he p:t"OI'l',,'w using .a,symptotic :;:;·e:rie5 "for H(x). For insight into the beooviOl!' of' K. consider th.e special csse

1'" .~ v'2:/2 .", O. v .... i. iIi'",,_ 37

Thi 5 wcml.d. h·e t~ '~. for insta:n.c e , if' • .•• ' Then. s:ett ing ~2: = v2{ t *" ~ t),

r =.O'l'e.nd.

0;2;. = :2.n{x/c lIs = a

.. 'hich I Md. not PI' evi clliAs.ly seen, ·The~.;: pre15 'ili'jj .... nery ver-s ion",· 10 f Black. and Sc:ho·.l~s [6] pre5~n.t a Ta.ylor ~erie:s: appr'oMh t·o the ,j[el'i·,,~ti.ono:f: their I!!.Od}~l.. It. is c.l.oae in 6p.:i..ri"j; to this appendix •

-,1

J

1

2

3 4,

.5

.. ,~

6. 8,OOE-09

~~. 8:,6, E-06 L 3383.E,-04 4,., ~"318E-O J

2.4191£-01

2..4l97!,-Ol

5,. 3:991,:6:-02

1.3383E~04

1. 4861E-06

G.OBOOE-09

g.~OOOE-10 6.1.

2~3610E-07 5.19

3,~ 15'11£-05

4.2.3

3.21 2.37 1. S3 0,. sa

2.2-50£-02 • .5d,66E-Ol

5. '0 _OE-O:

s. :134&-01

o. 2,9

9,. 72SE,-,Ol 9~9S6S!-Ol

0.,06 O~OO 0.00 0 .. 00 0.,00

9'. 9997E-Ol 1.0000E+OO

!.DCOOE+OO

\ ....

2'73

Refe:re..:..ces

jBJ.a.~k ~ F'iscbecl::.~ ItForecastiugi'm."'.::'.8Ji1ce clf Stock Fr'!ces for O'pt.iolUs "ITadiu:f~ end Other PI.tl'poses ~ II Pro.c~e~ding$ of the Seminar On tn~ J!.n;~lY'sis of Security Prices .. (November 1915): 297-306 ..

~ ._.......,. ,

,r

. "

2 • Black F':'sche:r, 1"The Pricing or ommodi ty C:ontr act is , I!'J ournaU. o'!"

Financia.l Bconceri ca , ·-0 __ . 3; Nos. l!2 (Jan/March 1.976); 1.61-l 9 ..

3.. Black,. Fischer and Seh/o,l.es.~ .Myron." UljI_ Tb.eol'etica1 Valua.tionF'·Q~e. for Qptions, We.rraut;s. and. Oth.~r Securities) ~t Fi:nancia.l Nate

No. 1.6B (Oc'tdbe:r 1 ~ .19701).

\ ...•

,f· ~ "_.--

.'

BlB:cs., Fischer and Scholes, .~Wrlon:!, 'Capital .Mark!et EquilibriiWll and the rri,ciIlg of' C:o!'1lorate ..... abd . ...:. . .:t:ieE ,. n r"{orking Ptalpe:r' No. 1.6C, Uni ve·l;' a i ty ot" Cb.ic~ag!O end Ms.E sa.ch~J;S et t s Tn sti tut e a f Tee ]raolo,gy

r :

I ,

~--'

t

\,- .-"

5 ..EJ.,~k ~ FischeT and Scho~es, Myron." uThe Valua.tion of Option Cem.tracts and a. Test of !.fa.rk'e:t :E:f.fi,ciency, IB' Jour~l O.r Finance 21 (~:"9 2); 399~·4~7 .

~r

I J

1 _"

6." illaJCk. Fiseher and Sch.ol·e:s: ~ M)'r'Ot!. ~,"Th.e Pricing of Opti.o-ns and Corpo·ra:te r.,ia.biliti .. es ~ '~I .J,o~ of Po.li'tical ECODOm:;r. (Me.y·June 1913): 637-654.

... --

7. Ca,pc)'zza., Dennis and Asay ,1ifichae':', I _esting the Black a.nd Scholes 1"f..cd,1e!.1 of. Cal_ Option ;7:a.iua:t':on, I ?re]lrint., Graduate School of' ~~.iness A&ninis:tre..tion~ Ucivers i."" y' 0:£ Southern Cui.t'ornia.

a.. Co:x:~, .John., nNotes on Option P:::-.i.ci.PJg I~ Constant E::1a..stici ty of' VOOE'ianC-E!

Diffusions ,,11 Pr~l?rint (Serpte:ml'DeGt" 1975).

{ ,

i

L .. -.

9. COX~ ,John and R,os$~ Stephen A .. ,. fl:....ne Pricing of Options' ror Jump Procaases ~ II r,.lorking Pape'l"lli'o.. 2'-15,. Rofuley L. dhite Cent~.r

Penn.sylvania (1975).

lO .O::it" ,JoiLm and, Ross; Stephen A.,. ,. u,Th.e' Va...Luation of Options for A.lt.,e..""!!I.a. t i VEl Stochastic Prec esse s ~ r ,J ourna.l of Fina.nc ial ,Ek:o:nOilildcs~. VoL 3~ Nos. l/2: (.J&i!l.~71~ch.1916):', 1,45-166.

11. raDle, B'urton~ The Sophistica.ted I~v~stQr;, nHwly revised and

Ie:xpamled by Sylvia C:reneE:isen1ohr ,', Simon a.nd. Shuster ~ 1 ffii'!" Y'Qrk~ 1964 (an Essandess: pa.~'!"OOc:k): 16ll-169 , 224.

1.2, .:-'~::::nb.o.lz. Robert end Zwnbl"l1D!l , John,. i Random wa.lkT,ri th Noi s,e and Stock Option Valua.tio'n,~ fl Hu:nt..eJt: College ~ Me;< York, (1975)-.,

!.3. F :,sher, L.alo;TEmc e sad Kamin. JUle$, " nCnth,e lature and Estimation of Systematic Risk~ H Uni1T€!rs1-y Ol!' Chii,eaglO (Februa;.ry 1975).

_4. "a_ -ai, Dan and ,Masulis, R.. W., II'The Op;l;ion Pricing Moa,el and the

Riillk ,P'is.,ctor of Stock~ II ,Journal of' ~i(l.a:nci$J. E:conomic~ ~ Vol. 3:) N,os. '-/2 (Ja.nu.ar:rJ~4arch 1976): 53-82.

15.. Inge:rsall. J. E., Jr, '. IIp' TheOlretica'- and Empirical Investiga.tion of' the Dua.l Purpos€!Funds,; ~4li, App':::',i.c,ation .of' Cont1ng;entC::taims ~l1maly~is) II'Journal of Fi:rn.a!lci'a.1.~CQrlomic5" Vol. 3; Nos. _/2 (Janua-ry!Mar'ch -976): 83-12:h.

16. Tnger'Sloll., J. E., ~Jr.; n'A Cont,itllgern;; Cla.ims Va.l.uatiou or COll:V'e:rtible Securities, ii C~r:ri;er r:-:'o!' Mat,hemgt,i.~&l Studi,~s in Busi,nes$ and &on~ic$, Report Mia. 7628. ~li1iversity of Chicago, (F,ebr"l..l.al"Y 1976).

17. Ki<ill.e!", P1eaood,y and COlllP8...11lY) Inc ... " -!leaping \¥~ th iI'f.arket Volat.ili ty:

Di.'ilf9.rsification Strategies ::":O!" Eq,;L_"-y Port fol,ios., tl Portf'o11.Q St.rate_gy ~ "I'heResea.rch Depe.l"1;ment (November 14 ) 1975).,

275

r -~ ...

18.

Kl'emkiosK"J. Robert c. @d ~~i!!j, ~ John D.) "The Adj ust_nt o:f iB~t'a Foree ast s ,.!~ ·Joi.ll"nal sf' _ Finane e x::r;:x' • No. 4 ( Sept e:m.o er

(

L __

1975): . 1123-112.8.

Le.t.en.le" .HBnry A. andR.enill_.~ ~B:i.cha:rd J. ~ nStarviarci De',ri.e.tions

10f' s.t o-ck Pr:1.c e lila tios ~ n Pl'epri:nt~, ( Oc t·ober 1.915).

",-.':IiI., "

\

L-

20 ,.LeabO'" D1ck A ..and. R5;lg~1,$1ti .~Ri,c"''' "<."d L., u'Warran.t Pric s Maveme!l1n:;s and tlll~ Eff'i c.i errt Market .Model, It ,.]i'Ollr!::!;al of' Fiua.n-c ~. lJL:{ ~~Ol • J!.

r·· .....

t :

~ .. _:

Omen 1915): 163-1.11,

r" ._-

~ . __ ._

21. • toliert; an, F;o bert; c .. ~ ~ 'Theo'ry of'Bat.iomll Option. hi e in.g ~ rr Bell JOUl''l:liru. of Econmrics an.dl ~~eJ!l1.ent Sci'!!!pee {Spring 1913): 111,1-18.3.

: ....... -

) .

t .. _ ~,

........

I

~ 'J.

... -~ i

_ 22. .Merton., Robert C .. " n'The .Tm.pcact;, on Opt,iol!'J. Pl"'i.c.ing of' Specit'1,cat1o:o.

Error ill the Undierlyi.ng Stock Price a.~ttu:'niS"~ 1'1 Working P&PI~(l" 829,- 7 6 ~ Sloan SchooJL of ~<l:g~me:n:t;" Mas sachlJ.sett, s I.ru:rti.t. ute: of: Tee l:mol.ogy ( J'S)lua:.l"'J' 1,916).

23. Meno.n, Robert C., nOpt1ortl! Pl'icing wl:l.e!l Underlaying Stock:. RetU!..l"'.!l5 are Ili, so Cl'Ili.t inuous ~,I~ J Cllll.l.CTI.a:l. of' Finan.ci al Economi c: s

Vol. 3. Nos • 1/2 {J"a.nuru:y/'t!,Erca 1976): 1:25-1 1,l 4 ,

.,." --.

) .

L~:

21::" MOI"g~nster:n.~ Oska..r, u'Tbirieen. Cri.t..icaJLif\oints in Corutem.pOl'e.ry Economic Theory. n ,~d. IID~sc.r'.ipti V1!E!, FTedicti ve and NO.r:m_ati ¥Ie

_ Theory ,I~ 'Wr i t iag P~perN"o. 3o~. New York Univer:$ i ty C~p;ri.l 1:912) •

)" .j

;

r

i _ ...

25... Scholes~, Myron, 1!Ta.x:.esand. 'the Pr'ioiIlg 0'£ Options ~ It Jour~. Q,f Fin.a.n:c,e, 11'0.1.. 3.l ~ Mo., :2 (May 197'6): 31.9-332.

i _

2·6... Si.!Il;t.h~ c ... w •• Jr .• ~10ptio!l.Pr:i.cii!!:g: ABeview~~' JOliIlrna...l OT

Finane i alEe onomi c s ,,'10.1.. 3 ~~os ... ll2 (J a.."ti;ual'¥ /Marc h 197:6); 3-,:2 .

, . 1

21. TboirP"EQfW!'-ard O ... ~ nport:foHo Choic'e and thiS' Kelly Criterion~~! .IToc·[~editi.g_s c.t th~' 1971 Business ,and Economic ~ . Se~t,ion, of the: 1\m,erican 8:tat is:tic;a.1 Ass;ocietion (1912): 2]5-,224.. To

Models i.n F'inance, ed. b-:r W. '1',. Ziem:ba~ S. L. Brumelle~ and Ft. G. ~lic:kson) Aca.,demic Press (-9"5); 599-619.

28. _m-p.Ed:~d O .. ~ "Opt Lens Ln Institutiona.l Portfolios, n

of' Security Pr· ces ,

'10.1. 20, Ho. 1, Uni vend ty of'

229-25L

29. "Thorp,. Edward o. and !Cas-soui' ~ Shee-'o" T.,) Beatth,e Market, Rand.om House. !Yle1f~'i' Yor-k (1967).