@article{bde29dfe0a294875aedc132b9b783af0,
title = "Option Profit and Loss Attribution and Pricing: A New Framework",
abstract = "This paper develops a new top-down valuation framework that links the pricing of an option investment to its daily profit and loss attribution. The framework uses the Black-Merton-Scholes option pricing formula to attribute the short-term option investment risk to variation in the underlying security price and the option's implied volatility. Taking risk-neutral expectation and demanding no dynamic arbitrage result in a pricing relation that links an option's fair implied volatility level to the underlying volatility level with corrections for the implied volatility's own expected direction of movement, its variance, and its covariance with the underlying security return.",
author = "Peter Carr and Liuren Wu",
note = "Funding Information: Peter Carr is with New York University. Liuren Wu is in the Department of Economics and Finance, Baruch College. We would like to thank Stefan Nagel (the Editor), the associate editor, and two anonymous referees. We would also like to thank Yun Bai; David Gershon; Kris Jacobs; Danling Jiang; Aaron Kim; Chun Lin; Jason Roth; Angel Serrat; Stoyan Stoyanov; seminar participants at Baruch College, Credit Suisse, RMIT, Stony Brook University, City University of New York Graduate Center, and the 2017 6th IFSID Conference on Derivatives for comments. Liuren Wu gratefully acknowledges the support of a grant from the City University of New York PSC‐CUNY Research Award Program. We have read disclosure policy and have no conflicts of interest to disclose. The Journal of Finance's Publisher Copyright: {\textcopyright} 2020 the American Finance Association Copyright: Copyright 2020 Elsevier B.V., All rights reserved.",
year = "2020",
month = aug,
day = "1",
doi = "10.1111/jofi.12894",
language = "English (US)",
volume = "75",
pages = "2271--2316",
journal = "Journal of Finance",
issn = "0022-1082",
publisher = "Wiley-Blackwell",
number = "4",
}