Option pricing and the arbitrage pricing theory

Option pricing and the arbitrage pricing theory

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Article ID: iaor201522876
Volume: 10
Issue: 1
Start Page Number: 1
End Page Number: 16
Publication Date: Mar 1987
Journal: Journal of Financial Research
Authors: ,
Keywords: investment
Abstract:

This paper applies the arbitrage pricing theory to option pricing. Under certain distribution assumptions or the assumption that there is only one common factor, the underlying asset of an option is the sole risky factor that explains its expected return. Based upon this relationship, a new and simple option‐pricing formula is derived, and some important existing option‐pricing formulae are reproduced. Empirical results show that the new formula performs as well as the Black‐Scholes formula.

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