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Date of Award

Spring 2012

Document Type

Restricted Thesis: Campus only access

Degree Name

Bachelor of Science



First Advisor

Dr. Ovidiu Lipan


This paper proposes an approach to option valuation, which is based on a generalization of the Fokker-Planck equation (also known as the Kolmogorov forward equation). The Fokker-Planck equation is a truncation of the general Kramers-Moyal (KM) expansion. This expansion has the advantage that it keeps all the coefficients - not merely those related to the drift and the diffusion of the process. Therefore, instead of focusing on the distribution of the underlier assets, one should look at the KM coefficients, as these will carry additional information about the stochastic process followed by the variable in question. By matching the coefficients of the KM expansion of the replicating portfolio - which can be estimated from data - with those of the option, one can get systems of equations for the price of the option. These equations can then be analyzed numerically.