Index-Option Pricing with Stochastic Volatility and the Value of Accurate Variance Forecasts

Index-Option Pricing with Stochastic Volatility and the Value of Accurate Variance Forecasts
Author: Robert F. Engle
Publisher:
Total Pages: 31
Release: 2010
Genre:
ISBN:

In pricing primary-market options and in making secondary markets, financial intermediaries depend on the quality of forecasts of the variance of the underlying assets. Hence, the gain from improved pricing of options would be a measure of the value of a forecast of underlying asset returns. NYSE index returns over the period of 1968-1991 are used to suggest that pricing index options of up to 90-days maturity would be more accurate when: (1) using ARCH specifications in place of a moving average of squared returns; (2) using Hull and White's (1987) adjustment for stochastic variance in Black and Scholes's (1973) formula; (3) accounting explicitly for weekends and the slowdown of variance whenever the market is closed.

Index-option Pricing with Stochastic Volatility and the Value of Accurate Variance Forecasts

Index-option Pricing with Stochastic Volatility and the Value of Accurate Variance Forecasts
Author: Robert F. Engle
Publisher:
Total Pages: 48
Release: 1993
Genre: Stock options
ISBN:

In pricing primary-market options and in making secondary markets, financial intermediaries depend on the quality of forecasts of the variance of the underlying assets. Hence, the gain from improved pricing of options would be a measure of the value of a forecast of underlying asset returns. NYSE index returns over the period of 1968-1991 are used to suggest that pricing index options of up to 90-days maturity would be more accurate when: (1) using ARCH specifications in place of a moving average of squared returns; (2) using Hull and White's (1987) adjustment for stochastic variance in Black and Scholes's (1973) formula; (3) accounting explicitly for weekends and the slowdown of variance whenever the market is closed.

Empirical Performance of Option Pricing Models with Stochastic Local Volatility

Empirical Performance of Option Pricing Models with Stochastic Local Volatility
Author: Greg Orosi
Publisher:
Total Pages: 16
Release: 2014
Genre:
ISBN:

We examine the empirical performance of several stochastic local volatility models that are the extensions of the Heston stochastic volatility model. Our results indicate that the stochastic volatility model with quadratic local volatility significantly outperforms the stochastic volatility model with CEV type local volatility. Moreover, we compare the performance of these models to several other benchmarks and find that the quadratic local volatility model compares well to the best performing option pricing models reported in the current literature for European-style S&P500 index options. Our results also indicate that the model with quadratic local volatility reproduces the characteristics of the implied volatility surface more accurately than the Heston model. Finally, we demonstrate that capturing the shape of the implied volatility surface is necessary to price binary options accurately.

Stochastic Dominance Option Pricing

Stochastic Dominance Option Pricing
Author: Stylianos Perrakis
Publisher: Springer
Total Pages: 294
Release: 2019-05-03
Genre: Business & Economics
ISBN: 3030115909

This book illustrates the application of the economic concept of stochastic dominance to option markets and presents an alternative option pricing paradigm to the prevailing no arbitrage simultaneous equilibrium in the frictionless underlying and option markets. This new methodology was developed primarily by the author, working independently or jointly with other co-authors, over the course of more than thirty years. Among others, it yields the fundamental Black-Scholes-Merton option value when markets are complete, presents a new approach to the pricing of rare event risk, and uncovers option mispricing that leads to tradeable strategies in the presence of transaction costs. In the latter case it shows how a utility-maximizing investor trading in the market and a riskless bond, subject to proportional transaction costs, can increase his/her expected utility by overlaying a zero-net-cost portfolio of options bought at their ask price and written at their bid price, irrespective of the specific form of the utility function. The book contains a unified presentation of these methods and results, making it a highly readable supplement for educators and sophisticated professionals working in the popular field of option pricing. It also features a foreword by George Constantinides, the Leo Melamed Professor of Finance at the Booth School of Business, University of Chicago, USA, who was a co-author in several parts of the book.