On the Minimal Entropy Martingale Measure and Multinomial Lattices with Cumulants
Date
2012Author
Seera, Cyrus
Ivivi, Ssebugenyi
Mwaniki, Joseph
Konlack, Virginie S.
Type
ArticleLanguage
enMetadata
Show full item recordAbstract
In this article, we describe with relevant examples based on empirical data how to
use the minimal entropy martingale measure (MEMM) to price European and American Options
in multinomial lattices which take into account cumulants information. For trinomial lattices, we
show that minimal entropy prices are close to results obtained using the Black and Scholes option
pricing formula. For pentanomial lattices, minimal entropy prices are close to results obtained under
the mean-correcting martingale measure using the discrete Fourier transform. The MEMM is very
easy to compute and is therefore a good candidate for option pricing in multinomial lattices.