S-WoPEc
 
Scandinavian Working Papers in Economics
HomeAboutSeriesSubject/JEL codesAdvanced Search
Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2004/19:
The perpetual American put option for jump-diffusions: Implications for equity premiums

Knut K. Aase ()

Abstract: In this paper we solve an optimal stopping problem with an infinite time horizon, when the state variable follows a jump-diffusion. Under certain conditions our solution can be interpreted as the price of an American perpetual put option, when the underlying asset follows this type of process.

The probability distribution under the risk adjusted measure turns out to depend on the equity premium, which is not the case for the standard, continuous version. This difference is utilized to find intertemporal, equilibrium equity premiums.

We apply this technique to the US equity data of the last century, and find an indication that the risk premium on equity was about two and a half per cent if the risk free short rate was around one per cent. On the other hand, if the latter rate was about four per cent, we similarly find that this corresponds to an equity premium of around four and a half per cent.

The advantage with our approach is that we need only equity data and option pricing theory, no consumption data was necessary to arrive at these conclusions.

Various market models are studied at an increasing level of complexity, ending with the incomplete model in the last part of the paper.

Keywords: Optimal exercise policy; American put option; perpetual option; optimal stopping; incomplete markets; equity premiums; CCAPM; (follow links to similar papers)

JEL-Codes: D52; (follow links to similar papers)

36 pages, December 17, 2004

Before downloading any of the electronic versions below you should read our statement on copyright.
Download GhostScript for viewing Postscript files and the Acrobat Reader for viewing and printing pdf files.

Full text versions of the paper:

163726    PDF-file
Download Statistics

Questions (including download problems) about the papers in this series should be directed to Stein Fossen ()
Report other problems with accessing this service to Sune Karlsson () or Helena Lundin ().

Programing by
Design by Joachim Ekebom

Handle: RePEc:hhs:nhhfms:2004_019 This page was generated on 2014-12-14 19:25:10