European Option Pricing Formula in Risk-Aversive Markets

Abstract

In this study, using the method of discounting the terminal expectation value into its initial value, the pricing formulas for European options are obtained under the assumptions that the financial market is risk-aversive, the risk measure is standard deviation, and the price process of underlying asset follows a geometric Brownian motion. In particular, assuming the option writer does not need the risk compensation in a risk-neutral market, then the obtained results are degenerated into the famous Black–Scholes model (1973); furthermore, the obtained results need much weaker conditions than those of the Black–Scholes model. As a by-product, the obtained results show that the value of European option depends on the drift coefficient μ of its underlying asset, which does not display in the Black–Scholes model only because μ = r in a risk-neutral market according to the no-arbitrage opportunity principle. At last, empirical analyses on Shanghai 50 ETF options and S&P 500 options show that the fitting effect of obtained pricing formulas is superior to that of the Black–Scholes model.