Uncertain Stochastic Option Pricing in the Presence of Uncertain Jumps

In this paper, a new differential equation, driven by aleatory and epistemic forms of uncertainty, is introduced and applied to describe the dynamics of a stock price process. This novel class of differential equations is called uncertain stochastic differential equations(USDES) with uncertain jumps. The existence and uniqueness theorem for this class of differential equations is proposed and proved. An appropriate version of the chain rule is derived and applied to solve some examples of USDES with uncertain jumps. The differential equation discussed is applied in an American call option pricing problem. In this problem, it is assumed that the evolution of the stock price is driven by a Brownian motion, the Liu canonical process and an uncertain renewal process. MAT-LAB is employed for implementing the derived option pricing model. Results show that option prices from the proposed call option pricing formula increase as the jump size increases. As compared to the proposed call option pricing formula, the Black-Scholes overprices options for a certain range of strike prices and under-prices the same options for another range of exercise prices when the jump size is zero.