Pricing of European Options with Subjective Probability : Ambiguity aversion in the options market during the European sovereign debt crisis

University essay from Umeå universitet/Nationalekonomi

Author: Simon Edvinsson; [2016]

Keywords: ;

Abstract: This essay develops an option pricing formula where the market participantsare assumed to not follow a uniform approach with respect to uncertainty thatarises under extreme market events. By using a continuous Choquet randomwalk for modeling asset dynamics, as well as including marginal utility, an optionprice kernel is obtained- this is opposed to the unique price that arises inthe standard MMBS framework. By numerically backsolving for the ambiguityparameter, the impact of investor ambiguity aversion can be estimated fromobserved market option prices. This method is applied on European call optionswhere the underlying assets are various European bank equities observedduring the European sovereign debt crisis from late 2009 through early 2011.

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