2023, Vol. 8, Issue 5, Part C

The Ornstein-Uhlenbeck process has gained attention in the field of finance as a means of modelling the volatility of the underlying asset price. It is a stochastic process that models the behaviour of a variable over time. It is often used to model the mean-reverting process where the variable tends to return to a long-term average over time. It can model interest rates, volatilities and many more financial variables. The Ornstein-Uhlenbeck model offers a valuable framework for analysing and predicting the volatility of financial assets, allowing researchers to gain deeper insights into the dynamics of market fluctuations and make more informed decisions. It is notable that option pricing models assumes that there is no transaction cost in trading. To better reflect the dynamic nature of the market and accommodate real-world conditions, it is necessary to develop a model that considers this factor. Based on the findings of this study, we have applied a similar approach by incorporating transaction costs into the Ornstein-Uhlenbeck model and developed an asset pricing model using the Ornstein-Uhlenbeck model with transaction costs. This model allows for a comprehensive analysis of the factors influencing asset prices, including volatility and transaction costs. It also helps investors to gain insights into the impact of transaction costs on option prices within the context of the Ornstein-Uhlenbeck model, providing a more comprehensive understanding of the dynamics involved.