Learning Martingale Measures From High Frequency Financial Data to Help Option Pricing
Hung-Ching (Justin) Chen 0, Malik Magdon-Ismail
Hung-Ching (Justin) Chen
0Rensselaer Polytechnic Institute
Available Online October 2006.
- https://doi.org/10.2991/jcis.2006.126How to use a DOI?
- Financial Derivative, Martingale, Risk Neutral, Pricing
- We provide a framework for learning risk-neutral measures (Martingale measures) for pricing options from high frequency financial data. In a simple geometric Brownian motion model, a price volatility, a fixed interest rate and a no-arbitrage condition suffice to determine a unique risk-neutral measure. On the other hand, in our framework, we relax some of these assumptions to obtain a class of allowable risk-neutral measures. We then propose a framework for learning the appropriate risk-neural measure. Since the risk-neutral measure prices all options simultaneously, we can use all the option contracts on a particular underlying stock for learning. We demonstrate the performance of these models on historical data. In particular, we show that both learning without a no-arbitrage condition and a no-arbitrage condition without learning are worse than our framework; however the combination of learning with a no-arbitrage condition has the best result. These results indicate the potential to learn Martingale measures with a no-arbitrage condition providing just the right constraint. We also compare our approach to standard Binomial models with volatility estimates (historical volatility and GARCH volatility predictors). Finally, we illustrate the power of such a framework by developing a real time trading system based upon these pricing methods.
- Open Access
- This is an open access article distributed under the CC BY-NC license.
Cite this article
TY - CONF AU - Hung-Ching (Justin) Chen AU - Malik Magdon-Ismail PY - 2006/10 DA - 2006/10 TI - Learning Martingale Measures From High Frequency Financial Data to Help Option Pricing BT - 9th Joint International Conference on Information Sciences (JCIS-06) PB - Atlantis Press SN - 1951-6851 UR - https://doi.org/10.2991/jcis.2006.126 DO - https://doi.org/10.2991/jcis.2006.126 ID - Chen2006/10 ER -