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| Release | : 2000 |
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| Author | : George J. Jiang |
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| Total Pages | : 39 |
| Release | : 2000 |
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| Author | : George J. Jiang |
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| Total Pages | : 41 |
| Release | : 2013 |
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This paper specifies a multivariate stochastic volatility (SV) model for the Samp;P500 index and spot interest rate processes. We first estimate the multivariate SV model via the efficient method of moments (EMM) technique based on observations of underlying state variables, and then investigate the respective effects of stochastic interest rates, stochastic volatility, and asymmetric Samp;P500 index returns on option prices. We compute option prices using both reprojected underlying historical volatilities and the implied risk premium of stochastic volatility to gauge each model?s performance through direct comparison with observed market option prices on the index. Our major empirical findings are summarized as follows. First, while allowing for stochastic volatility can reduce the pricing errors and allowing for asymmetric volatility or quot;leverage effectquot; does help to explain the skewness of the volatility 'smile', allowing for stochastic interest rates has minimal impact on option prices in our case. Second, similar to Melino amp; Turnbull (1990), our empirical findings strongly suggest the existence of a non zero risk premium for stochastic volatility of asset returns. Based on the implied volatility risk premium, the SV models can largely reduce the option pricing errors, suggesting the importance of incorporating the information from the options market in pricing options. Finally, both the model diagnostics and option pricing errors in our study suggest that the Gaussian SV model is not sufficient in modeling short-term kurtosis of asset returns, an SV model with fatter-tailed noise or jump component may have better explanatory power.
| Author | : Maria Cristina Recchioni |
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| Total Pages | : 38 |
| Release | : 2016 |
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The profound financial crisis generated by the collapse of Lehman Brothers and the European sovereign debt crisis in 2011 have caused negative values of government bond yields both in the U.S.A. and in the EURO area. This paper investigates whether the use of models which allow for negative interest rate can improve option pricing and implied volatility forecasting. This is done with special attention to Foreign eXchange and index options. To this end, we carried out an empirical analysis of the prices of call and put options on the U.S. S&P 500 index as well as on the Eurodollar futures using a generalization of the Heston model in the stochastic interest rate framework. Specifically, the dynamics of the option's underlying asset is described by two factors: a stochastic variance and a stochastic interest rate. The volatility is not allowed to be negative while the interest rate is. Explicit formulas for the transition probability density function and moments are derived. These formulas are used to efficiently estimate the model parameters. Three empirical analyses are illustrated. The first two show that the use of models which allow for negative interest rates can efficiently reproduce implied volatility and forecast option prices (i.e. S&P index and foreign exchange options). The last one studies how the U.S. three month government bond yield affects the U.S. S&P 500 index.
| Author | : Zhiwu Chen |
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| Release | : 2000 |
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Recent empirical studies find that once an option pricing model has incorporated stochastic volatility, allowing interest rates to be stochastic does not improve pricing or hedging any further while adding random jumps to the modeling framework only helps the pricing of extremely short-term options but not the hedging performance. Given that only options of relatively short terms are used in existing studies, this paper addresses two related questions: Do long-term options contain different information than short-term options? If so, can long-term options better differentiate among alternative models? Our inquiry starts by first demonstrating analytically that differences among alternative models usually do not surface when applied to short term options, but do so when applied to long-term contracts. For instance, within a wide parameter range, the Arrow-Debreu state price densities implicit in different stochastic-volatility models coincide almost everywhere at the short horizon, but diverge at the long horizon. Using regular options (of less than a year to expiration) and LEAPS, both written on the Samp;P 500 index, we find that short- and long-term contracts indeed contain different information and impose distinct hurdles on any candidate option pricing model. While the data suggest that it is not as important to model stochastic interest rates or random jumps (beyond stochastic volatility) for pricing LEAPS, incorporating stochastic interest rates can nonetheless enhance hedging performance in certain cases involving long-term contracts.
| Author | : Greg Orosi |
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| Total Pages | : 16 |
| Release | : 2014 |
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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.
| Author | : Pascal Debus |
| Publisher | : GRIN Verlag |
| Total Pages | : 59 |
| Release | : 2013-09-09 |
| Genre | : Business & Economics |
| ISBN | : 3656491941 |
Bachelorarbeit aus dem Jahr 2010 im Fachbereich BWL - Investition und Finanzierung, Note: 1,2, EBS Universität für Wirtschaft und Recht, Sprache: Deutsch, Abstract: The Black-Scholes (or Black-Scholes-Merton) Model has become the standard model for the pricing of options and can surely be seen as one of the main reasons for the growth of the derivative market after the model ́s introduction in 1973. As a consequence, the inventors of the model, Robert Merton, Myron Scholes, and without doubt also Fischer Black, if he had not died in 1995, were awarded the Nobel prize for economics in 1997. The model, however, makes some strict assumptions that must hold true for accurate pricing of an option. The most important one is constant volatility, whereas empirical evidence shows that volatility is heteroscedastic. This leads to increased mispricing of options especially in the case of out of the money options as well as to a phenomenon known as volatility smile. As a consequence, researchers introduced various approaches to expand the model by allowing the volatility to be non-constant and to follow a sto-chastic process. It is the objective of this thesis to investigate if the pricing accuracy of the Black-Scholes model can be significantly improved by applying a stochastic volatility model.
| Author | : Alexander van Haastrecht |
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| Total Pages | : 45 |
| Release | : 2009 |
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We consider the pricing of FX, inflation and stock options under stochastic interest rates and stochastic volatility, for which we use a generic multi-currency framework. We allow for a general correlation structure between the drivers of the volatility, the inflation index, the domestic (nominal) and the foreign (real) rates. Having the flexibility to correlate the underlying FX/Inflation/Stock index with both stochastic volatility and stochastic interest rates yields a realistic model, which is of practical importance for the pricing and hedging of options with a long-term exposure. We derive explicit valuation formulas for various securities, such as vanilla call/put options, forward starting options, inflation-indexed swaps and inflation caps/floors. These vanilla derivatives can be valued in closed-form under Schobel and Zhu (1999) stochastic volatility, whereas we devise an (Monte Carlo) approximation in the form of a very effective control variate for the general Heston (1993) model. Finally, we numerical investigate the quality of this approximation and consider a calibration example to FX market data.
| Author | : Saikat Nandi |
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| Total Pages | : 48 |
| Release | : 1996 |
| Genre | : Hedging (Finance) |
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| Author | : Robert F. Engle |
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| Total Pages | : 48 |
| Release | : 1993 |
| Genre | : Stock options |
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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.
