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Equilibrium asset and option pricing under jump diffusion. (English) Zbl 1278.91069
Summary: This paper develops an equilibrium asset and option pricing model in a production economy under jump diffusion. The model provides analytical formulas for an equity premium and a more general pricing kernel that links the physical and risk-neutral densities. The model explains the two empirical phenomena of the negative variance risk premium and implied volatility smirk if market crashes are expected. Model estimation with the S&P 500 index from 1985 to 2005 shows that jump size is indeed negative and the risk aversion coefficient has a reasonable value when taking the jump into account.

MSC:
91B25 Asset pricing models (MSC2010)
91G20 Derivative securities (option pricing, hedging, etc.)
60J60 Diffusion processes
60J75 Jump processes (MSC2010)
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