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Applying the Cherny-Shiryaev-Yor invariance principle, we introduce ageneralized Jarrow-Rudd (GJR) option pricing model with uncertainty driven by askew random walk. The GJR pricing tree exhibits skewness and kurtosis in boththe natural and risk-neutral world. We construct implied surfaces for theparameters determining the GJR tree. Motivated by Merton's pricing treeincorporating transaction costs, we extend the GJR pricing model to include ahedging cost. We demonstrate ways to fit the GJR pricing model to a marketdriver that influences the price dynamics of the underlying asset. Wesupplement our findings with numerical examples.

Market Complete Option Valuation using a Jarrow-Rudd Pricing Tree with Skewness and Kurtosis