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Comment on “A New Simple Square Root Option Pricing Model” written by Camara and Wang

This paper presents a new option pricing model based on a general equilibrium framework, offering simplicity, preference-free formulas, and the ability to generate a negative skewed implied volatility curve.

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Comment on “A New Simple Square Root Option Pricing Model” written by Camara and Wang

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  1. Comment on “A New Simple Square Root Option Pricing Model”written by Camara and Wang San-Lin Chung Department of Finance National Taiwan University

  2. Summary of the paper This paper derives a new option pricing model under the general equilibrium framework. The new option pricing formulae are attractive because (1) they are simple, (2) are preference free, and (3) can generate negative skewed implied volatility curve.

  3. Main contributions of the paper Provide a new option pricing model based on a general equilibrium framework.

  4. Suggestions and Comments Given the fact that there are already a lot of option pricing models in the literature, the authors should give stronger motivations for providing another option pricing model. Why bother to provide another option model which can generate negative skewed implied volatility? In this paper, the aggregate wealth follows displaced lognormal distribution and the individual stock price follows the square root distribution. It is difficult to understand why they follow totally different probability distributions.

  5. Suggestions and Comments One potential problem is that the proposed model can not price options with strike prices smaller than alpha.

  6. Suggestions and Comments I am curious about the asymptotic property of the proposed option pricing model when the volatility increases to infinity. In the BS model, the call price will converge to the underlying asset price when the volatility increases to infinity. It seems that the proposed model collapses when the volatility increases to infinity.

  7. Suggestions and Comments In this paper, they compare the empirical performance of the proposed model with that of the BS model. I would suggest the authors to choose another benchmark model, such as CEV model and Merton’s jump-diffusion model, because it is too easy to beat the BS model.

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