Testing option pricing with the Edgeworth expansion

There is a well-developed framework, the Black-Scholes theory, for the pricing of contracts based on the future prices of certain assets, called options. This theory assumes that the probability distribution of the returns of the underlying asset is a Gaussian distribution. However, it is observed in the market that this hypothesis is flawed, leading to the introduction of a fudge factor, the so-called volatility smile. Therefore, it would be interesting to explore extensions of the Black-Scholes theory to non-Gaussian distributions. In this paper, we provide an explicit formula for the price of an option when the distributions of the returns of the underlying asset is parametrized by an Edgeworth expansion, which allows for the introduction of higher independent moments of the probability distribution, namely skewness and kurtosis. We test our formula with options in the Brazilian and American markets, showing that the volatility smile can be reduced. We also check whether our approach leads to more efficient hedging strategies of these instruments. (C) 2004 Elsevier B.V. All rights reserved.

A statistical law for multiplicities of SU(3) irreps (lambda, mu) in the plethysm {eta} circle times(3) {m} -> (lambda, mu)

A statistical law for the multiplicities of the SU(3) irreps (lambda, mu) in the reduction of totally symmetric irreducible representations {m} of U(N), N = (eta + 1) (eta + 2)/2 with eta being the three-dimensional oscillator major shell quantum number, is derived in terms of the quadratic and cubic invariants of SU(3), by determining the first three terms of an asymptotic expansion for the multiplicities. To this end, the bivariate Edgeworth expansion known in statistics is used. Simple formulae, in terms of m and eta, for all the parameters in the expansion are derived. Numerical tests with large m and eta = 4, 5 and 6 show good agreement with the statistical formula for the SU(3) multiplicities.