OPTION PRICING WITH TIME-CHANGED FRACTIONAL BROWNIAN MOTION: A FRACTIONAL VARIANCE GAMMA MODEL

We are pleased to announce a new paper by Professors Robert Jarrow and Jayen Tan:

OPTION PRICING WITH TIME-CHANGED FRACTIONAL

BROWNIAN MOTION: A FRACTIONAL VARIANCE GAMMA MODEL

Robert Jarrow¹ and Jayen Tan^1,2

• 1 Samuel Curtis Johnson Graduate School of Management, Cornell University, USA
• 2 Division of Finance, Nanyang Business School, Nanyang Technological University, Singapore

(Communicated by Dilip Madan)

Abstract. Fractional Brownian motion (fBm) exhibits attractive features for financial modeling, including long-range dependence, path roughness, and anomalous diffusion. However, its non-semimartingale nature precludes the use of conventional no-arbitrage approaches to option pricing. We address this limitation by introducing a time-changed fBm, obtained by evaluating fBm at stochastic gamma activity time, where activity time represents cumulative executed trading time. The resulting process retains the defining properties of fBm while recovering the semimartingale structure. Building on this construction, we develop the fractional Variance Gamma (fVG) model and propose a generalized method of moments (GMM) estimation procedure for option pricing. An empirical analysis of the S&P 500 yields an estimated Hurst exponent of approximately 0.47, consistent with mildly sublinear temporal scaling of return moments.

The full text of the paper is available here: