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What Type of Process Underlies Options? A Simple Robust Test
Author(s) -
Carr Peter,
Wu Liuren
Publication year - 2003
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1046/j.1540-6261.2003.00616.x
Subject(s) - simple (philosophy) , asset (computer security) , index (typography) , zero (linguistics) , economics , econometrics , component (thermodynamics) , process (computing) , jump , maturity (psychological) , type (biology) , mathematical economics , range (aeronautics) , mathematics , computer science , mathematical optimization , engineering , psychology , developmental psychology , philosophy , linguistics , physics , computer security , epistemology , quantum mechanics , world wide web , thermodynamics , operating system , ecology , biology , aerospace engineering
We develop a simple robust method to distinguish the presence of continuous and discontinuous components in the price of an asset underlying options. Our method examines the prices of at‐the‐money and out‐of‐the‐money options as the option's time‐to‐maturity approaches zero. We show that these prices converge to zero at speeds that depend upon whether the underlying asset price process is purely continuous, purely discontinuous, or a combination of both. We apply the method to S&P 500 index options and find the existence of both a continuous component and a jump component in the index.