An Event Option Pricing Model with Scheduled and
Unscheduled Announcement Effects
Finance and Economics Department, King Fahd University of Petroleum and Minerals, Dhahran, Saudi Arabia
WILLIAM M. TAYLOR
School of Business, Rutgers University, New Brunswick, New Jersey 08903
Abstract. There is considerable evidence supporting the time-varying distribution of asset returns. There is also
ample evidence that scheduled announcement events such as money supply announcements (in the case of for-
eign exchange), earnings announcements (in the case of stocks), and crop reports (in the case of commodities),
as well as random unscheduled events, can affect the level and volatility of asset returns. This study provides an
Event Model for European call options which explicitly addresses effects of these two classes of events. This
specification requires estimation of more parameters, but it could provide a more accurate basis for pricing
options than previous Poisson jump-diffusion models. Parametric analysis shows that the standard models under-
price the options relative to the Event Model. The Event Model may be particularly useful in pricing short-term
deep out-of-the-money options when scheduled events are present in the market.
Keywords: options, jump-diffusion models, announcement effects, scheduled events
There is considerable empirical evidence that asset return distributions are time-vary-
ing. This is demonstrated, in the case of stocks, by Patell and Wolfson (1981, 1984),
French and Roll (1986), Karpoff (1987), Penman (1987), Schwert (1989), Bailey
(1990), and others. Similarly, Cumby and Obstfeld (1981), Bailey (1988), Jorion
(1988), Giovannini and Jorion (1989), Hsieh (1989), and others, point to the time-vary-
ing distributions of foreign exchange returns. Time-varying price change distributions
in commodity markets are discussed in Milonas (1987), Fortenbery and Sumner (1993),
and others. The time-variation in the distributional properties of asset returns is gener-
ally associated with the flow of information (news). The theoretical link between infor-
mation flow and price evolution is explored in a number of studies. For example,
Admati and Pfleiderer (1988) consider volume and volatility in markets with differen-
tially informed traders, and Ross (1989) directly models the relationship between infor-
mation flow and volatility.
In the options literature, information effects are generally treated as Poisson processes.
Merton (1976) uses a Poisson jump-diffusion process to value stock options. However, not
all information flows have this random arrival characteristic. Rather, there exists a class of
information flows which are scheduled, and hence, their arrival times are known a priori. The
jump-diffusion formulation of asset returns ignores the existence of scheduled events and,
therefore, their possibly distinct effects on return distributions and option values. While con-
siderable theoretical and empirical work has been done on the unscheduled random type of
events, little work has been directed toward the effects of scheduled events on option pricing.
Review of Quantitative Finance and Accounting, 8 (1997): 151–162
© 1997 Kluwer Academic Publishers, Boston. Manufactured in The Netherlands.