Pricing European Option Under Fuzzy Mixed Fractional Brownian Motion Model with Jumps

Research output: Journal Publications and Reviews (RGC: 21, 22, 62)21_Publication in refereed journalpeer-review

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Original languageEnglish
Journal / PublicationComputational Economics
Online published10 Sep 2020
Publication statusOnline published - 10 Sep 2020

Abstract

As we all know, the financial environment on which option prices depend is very complex and fuzzy, which is mainly affected by the risk preferences of investors, economic policies, markets and other non-random uncertainty. Thus, the input data in the options pricing formula cannot be expected to be precise. However, fuzzy set theory has been introduced as a main method for modeling the uncertainties of the input parameters in the option pricing model. In this paper, we discuss the pricing problem of European options under the fuzzy environment. Specifically, to capture the features of long memory and jump behaviour in financial assets, we propose a fuzzy mixed fractional Brownian motion model with jumps. Subsequently, we present the fuzzy prices of European options under the assumption that the underlying stock price, the risk-free interest rate, the volatility, the jump intensity and the mean value and variance of jump magnitudes are all fuzzy numbers. This assumption allows the financial investors to pick any option price with an acceptable belief degree to make investment decisions based on their risk preferences. In order to obtain the belief degree, the interpolation search algorithm has been proposed. Numerical analysis and examples are also presented to illustrate the performance of our proposed model and the designed algorithm. Finally, empirically studies are performed by utilizing the underlying SSE 50 ETF returns and European options written on SSE 50 ETF. The empirical results indicate that the proposed pricing model is reasonable and can be treated as a reference pricing tool for financial analysts or investors.

Research Area(s)

  • European option pricing, Fuzzy jump-diffusion, Fuzzy stochastic differential equation, Interpolation search algorithm, Mixed fractional Brownian motion