2025/12/17 by Virk, Hamza, Wu, Yihren, John, Majnu
Economics, Econometrics and Finance · #Stochastic processes and financial applications #Complex Systems and Time Series Analysis #Financial Markets and Investment Strategies
paper · doi:10.48550/arxiv.2512.15071
Standard jump-diffusion models assume independence between jumps and diffusion components. We develop a multi-type jump-diffusion model where jump occurrence and magnitude depend on contemporaneous diffusion movements. Unlike previous one-sided models that create arbitrage opportunities, our framework includes upward and downward jumps triggered by both large upward and large downward diffusion increments. We derive the explicit no-arbitrage condition linking the physical drift to model parameters and market risk premia by constructing an Equivalent Martingale Measure using Girsanov's theorem and a normalized Esscher transform. This condition provides a rigorous foundation for arbitrage-free pricing in models with diffusion-dependent jumps.