INFORMATION-TIME OPTION PRICING - THEORY AND EMPIRICAL-EVIDENCE

With a stochastic time change from calendar-time to information-time, we derive a parsimonious option pricing formula with stochastic volati lity as a risk-neutral Poisson sum of Merton's (1973) prices over the option's information-time maturity domain. The formula contains two un observable parameters, information arrival intensity and information-t ime asset volatility, with stochastic volatility induced by random inf ormation arrival. When the information arrival rate intensifies, the o ption price increases and vice-versa. We test the formula in pricing, hedging, and excess profits capture empirically using currency and the S&P 500 futures options transaction data. (C) 1998 Elsevier Science S .A. All rights reserved.