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Gamma Pricing Model

What is 'Gamma Pricing Model'

An equation for determining the fair market value of a European-style option when the price movement on the underlying asset does not resemble a normal distribution. The gamma pricing model is intended to price options where the underlying asset has a distribution that is either long-tailed or skewed, where dramatic market moves occur with greater frequency than would be predicted by a normal distribution of returns.

Explaining 'Gamma Pricing Model'

While the Black-Scholes option pricing model is the best known, it does not provide accurate pricing results under all situations. In particular, the Black-Scholes model assumes that the underlying instrument has returns that are normally distributed. As a result, the Black-Scholes will misprice options on instruments that do not trade based on a normal distribution. Many alternative options pricing methods have been developed with the goal of providing more accurate pricing for real-world applications such as the Gamma Pricing Model. Generally speaking, the Gamma Pricing Model measures the gamma, which is how much fast the delta changes with respect to small changes in the underlying asset's price.


Further Reading


The variance gamma process and option pricing
academic.oup.com [PDF]
… THE VARIANCE GAMMA PROCESS AND OPTION PRICING … There are three option pricing formulas nested in the option pricing formula (25 … The data employed was the 691 daily observations of log spot price relatives covering the period from January 1992 to September …

The variance gamma (VG) model for share market returnsThe variance gamma (VG) model for share market returns
www.jstor.org [PDF]
… THE VARIANCE GAMMA PROCESS AND OPTION PRICING … There are three option pricing formulas nested in the option pricing formula (25 … The data employed was the 691 daily observations of log spot price relatives covering the period from January 1992 to September …

An empirical test of the variance gamma option pricing modelAn empirical test of the variance gamma option pricing model
www.sciencedirect.com [PDF]
… THE VARIANCE GAMMA PROCESS AND OPTION PRICING … There are three option pricing formulas nested in the option pricing formula (25 … The data employed was the 691 daily observations of log spot price relatives covering the period from January 1992 to September …

An empirical examination of the variance‐gamma model for foreign currency optionsAn empirical examination of the variance‐gamma model for foreign currency options
www.jstor.org [PDF]
… THE VARIANCE GAMMA PROCESS AND OPTION PRICING … There are three option pricing formulas nested in the option pricing formula (25 … The data employed was the 691 daily observations of log spot price relatives covering the period from January 1992 to September …

Asian options, the sum of lognormals, and the reciprocal gamma distributionAsian options, the sum of lognormals, and the reciprocal gamma distribution
www.worldscientific.com [PDF]
… THE VARIANCE GAMMA PROCESS AND OPTION PRICING … There are three option pricing formulas nested in the option pricing formula (25 … The data employed was the 691 daily observations of log spot price relatives covering the period from January 1992 to September …

A conditional autoregressive range model with gamma distribution for financial volatility modellingA conditional autoregressive range model with gamma distribution for financial volatility modelling
www.sciencedirect.com [PDF]
… THE VARIANCE GAMMA PROCESS AND OPTION PRICING … There are three option pricing formulas nested in the option pricing formula (25 … The data employed was the 691 daily observations of log spot price relatives covering the period from January 1992 to September …

Option pricing using variance gamma Markov chainsOption pricing using variance gamma Markov chains
link.springer.com [PDF]
… THE VARIANCE GAMMA PROCESS AND OPTION PRICING … There are three option pricing formulas nested in the option pricing formula (25 … The data employed was the 691 daily observations of log spot price relatives covering the period from January 1992 to September …

The entropy theory of stock option pricingThe entropy theory of stock option pricing
www.worldscientific.com [PDF]
… THE VARIANCE GAMMA PROCESS AND OPTION PRICING … There are three option pricing formulas nested in the option pricing formula (25 … The data employed was the 691 daily observations of log spot price relatives covering the period from January 1992 to September …



Q&A About Gamma Pricing Model


How can you use this information to make better decisions about your investments?

You can use this information to make better decisions about your investments because you know what factors affect them most significantly.

What are some examples of instruments that do not trade based on a normal distribution?

Some examples include stocks, commodities and foreign exchange.

How accurate is the Black-Scholes option pricing model?

While it is very accurate, it does have its limitations.

Why was another method needed to accurately price options in real world applications such as those mentioned above?

To account for situations where returns were not normally distributed or where dramatic market moves occurred more frequently than predicted by a normal distribution.

What are some limitations of the Black-Scholes option pricing model?

It assumes that returns are normally distributed and that there will be no dramatic market moves.

What types of assets do these alternative methods tend to be applied towards ?

Alternative methods tend to be applied towards stocks, commodities and foreign exchange instruments .

How does one measure how much fast delta changes with respect to small changes in the underlying asset's price using this method?

Gamma measures how much fast delta changes with respect to small changes in the underlying asset's price.

Are there any other methods used for calculating options prices besides these two models discussed here ?

Yes, there are many other methods used for calculating options prices besides these two models discussed here .

What is the gamma pricing model?

The gamma pricing model is an equation for determining the fair market value of a European-style option when the price movement on the underlying asset does not resemble a normal distribution.