Tail Risk Signal Detection through a Novel EGB2 Option Pricing Model
Connecting derivative pricing with tail risk management has become urgent for financial practice and academia. This paper proposes a novel option pricing model based on the exponential generalized beta of the second kind (EGB2) distribution. The newly proposed model is of generality, simplicity, rob...
| Main Authors: | , , |
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| Format: | Article |
| Language: | English |
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MDPI AG
2023-07-01
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| Series: | Mathematics |
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| Online Access: | https://www.mdpi.com/2227-7390/11/14/3194 |
| _version_ | 1827732576567033856 |
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| author | Hang Lin Lixin Liu Zhengjun Zhang |
| author_facet | Hang Lin Lixin Liu Zhengjun Zhang |
| author_sort | Hang Lin |
| collection | DOAJ |
| description | Connecting derivative pricing with tail risk management has become urgent for financial practice and academia. This paper proposes a novel option pricing model based on the exponential generalized beta of the second kind (EGB2) distribution. The newly proposed model is of generality, simplicity, robustness, and financial interpretability. Most importantly, one can detect tail risk signals by calibrating the proposed model. The model includes the seminal Black–Scholes (B−S) formula as a limit case and can perfectly “replicate” the option prices from Merton’s jump-diffusion model. Based on the proposed pricing model, three tail risk warning measures are introduced for tail risk signals detection: the EGB2 implied tail index, the EGB2 implied Value-at-Risk (EGB2-VaR), and the EGB2 implied risk-neutral density (EGB2 R.N.D.). Empirical results show that the new pricing model can yield higher pricing accuracy than existing models in normal and crisis periods, and three model-based tail risk measures can perfectly detect tail risk signals before financial crises. |
| first_indexed | 2024-03-11T00:52:04Z |
| format | Article |
| id | doaj.art-b6948e19e65b4ba49570e5d5d7a1dc04 |
| institution | Directory Open Access Journal |
| issn | 2227-7390 |
| language | English |
| last_indexed | 2024-03-11T00:52:04Z |
| publishDate | 2023-07-01 |
| publisher | MDPI AG |
| record_format | Article |
| series | Mathematics |
| spelling | doaj.art-b6948e19e65b4ba49570e5d5d7a1dc042023-11-18T20:21:58ZengMDPI AGMathematics2227-73902023-07-011114319410.3390/math11143194Tail Risk Signal Detection through a Novel EGB2 Option Pricing ModelHang Lin0Lixin Liu1Zhengjun Zhang2Department of Agricultural and Consumer Economics, University of Illinois at Urbana-Champaign, Urbana, IL 61801, USASchool of Statistics, University of International Business and Economics, Beijing 100029, ChinaSchool of Economics and Management, University of Chinese Academy of Sciences, Beijing 100190, ChinaConnecting derivative pricing with tail risk management has become urgent for financial practice and academia. This paper proposes a novel option pricing model based on the exponential generalized beta of the second kind (EGB2) distribution. The newly proposed model is of generality, simplicity, robustness, and financial interpretability. Most importantly, one can detect tail risk signals by calibrating the proposed model. The model includes the seminal Black–Scholes (B−S) formula as a limit case and can perfectly “replicate” the option prices from Merton’s jump-diffusion model. Based on the proposed pricing model, three tail risk warning measures are introduced for tail risk signals detection: the EGB2 implied tail index, the EGB2 implied Value-at-Risk (EGB2-VaR), and the EGB2 implied risk-neutral density (EGB2 R.N.D.). Empirical results show that the new pricing model can yield higher pricing accuracy than existing models in normal and crisis periods, and three model-based tail risk measures can perfectly detect tail risk signals before financial crises.https://www.mdpi.com/2227-7390/11/14/3194tail risksasymmetric returnsheavy tailsoption pricing |
| spellingShingle | Hang Lin Lixin Liu Zhengjun Zhang Tail Risk Signal Detection through a Novel EGB2 Option Pricing Model Mathematics tail risks asymmetric returns heavy tails option pricing |
| title | Tail Risk Signal Detection through a Novel EGB2 Option Pricing Model |
| title_full | Tail Risk Signal Detection through a Novel EGB2 Option Pricing Model |
| title_fullStr | Tail Risk Signal Detection through a Novel EGB2 Option Pricing Model |
| title_full_unstemmed | Tail Risk Signal Detection through a Novel EGB2 Option Pricing Model |
| title_short | Tail Risk Signal Detection through a Novel EGB2 Option Pricing Model |
| title_sort | tail risk signal detection through a novel egb2 option pricing model |
| topic | tail risks asymmetric returns heavy tails option pricing |
| url | https://www.mdpi.com/2227-7390/11/14/3194 |
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