Arbitrage ­free option pricing models 

Stochastics Seminar
Thursday, October 1, 2009 - 15:00
1 hour (actually 50 minutes)
Skiles 269
University of North Florida
The Black‐Scholes model for stock price as geometric Brownian motion, and the corresponding European option pricing formula, are standard tools in mathematical finance. In the late seventies, Cox and Ross developed a model for stock price based on a stochastic differential equation with fractional diffusion coefficient. Unlike the Black‐Scholes model, the model of Cox and Ross is not solvable in closed form, hence there is no analogue of the Black‐Scholes formula in this context. In this talk, we discuss a new method, based on Stratonovich integration, which yields explicitly solvable arbitrage‐free models analogous to that of Cox and Ross. This method gives rise to a generalized version of the Black‐Scholes partial differential equation. We study solutions of this equation and a related ordinary differential equation.