Empirical Performance of Alternative Option Pricing Models

1997/12/01 by Gurdip Bakshi, Charles Cao, Zhiwu Chen · 23 citations
Economics, Econometrics and Finance · Social Sciences · #Stochastic processes and financial applications #Capital Investment and Risk Analysis #Insurance, Mortality, Demography, Risk Management

paper · pdf · doi:10.1111/j.1540-6261.1997.tb02749.x

Abstract

ABSTRACT Substantial progress has been made in developing more realistic option pricing models. Empirically, however, it is not known whether and by how much each generalization improves option pricing and hedging. We fill this gap by first deriving an option model that allows volatility, interest rates and jumps to be stochastic. Using S&P 500 options, we examine several alternative models from three perspectives: (1) internal consistency of implied parameters/volatility with relevant time‐series data, (2) out‐of‐sample pricing, and (3) hedging. Overall, incorporating stochastic volatility and jumps is important for pricing and internal consistency. But for hedging, modeling stochastic volatility alone yields the best performance.

Citations

• Conditional Heteroskedasticity in Asset Returns: A New Approach
• The Pricing of Options and Corporate Liabilities
• A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity

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