AN OPTION VALUATION FRAMEWORK BASED ON ARITHMETIC BROWNIAN MOTION: JUSTIFICATION AND IMPLEMENTATION ISSUES

© 2017 The Southern Finance Association and the Southwestern Finance Association We examine arithmetic Brownian motion as an alternative framework for option valuation and related tasks. After reexamining empirical evidence, we compare and contrast option valuation based on one of the simplest forms of geometric Brownian motion with arithmetic Brownian motion. We identify an enhanced way to handle negative stock prices within arithmetic Brownian motion that is consistent with empirical observation. We review numerous strengths and weaknesses of both approaches. The arithmetic Brownian motion framework allows for the aggregation of any number of correlated factors for risk analysis