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 volatility as a risk-neutral Poisson sum of Merton's (1973) prices over the option's information-time maturity domain. The formula contains two unobservable parameters, information arrival intensity and information-time asset volatility, with stochastic volatility induced by random information arrival. When the information arrival rate intensifies, the option 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.