1. Brigham Young University , O. Leslie and Dorothy C. Stone Professor, Provo, Utah, 84602;2. Morgan Stanley and Company , 1251 Avenue of the Americas, New York, New York, 10020Principal
Abstract:
The Black Scholes formula has been widely used to price financial instruments. The derivation of this formula is based on the assumption of lognormally distributed returns which is often in poor agreement with actual data. An option pricing formula based on the generalized beta of the second kind (GB2) is presented. This formula includes the Black Scholes formula as a special case and accommodates a wide variety of nonlognormally distributed returns. The sensitivity of option values to departures from the skewness and kurtosis associated with the lognormal distribution is investigated.