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arXiv · 2512.15071

Arbitrage-Free Pricing with Diffusion-Dependent Jumps

Hamza Virk·Yihren Wu·Majnu John
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Abstract

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.

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Hamza Virk, Yihren Wu, Majnu John. 2025-12-17. Arbitrage-Free Pricing with Diffusion-Dependent Jumps. https://arxiv.org/abs/2512.15071

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