Smile from the past: a general option pricing framework with multiple volatility and leverage components

DOI10.1016/J.JECONOM.2015.02.036zbMATH Open1337.91149arXiv1404.3555OpenAlexW1530878941MaRDI QIDQ2347728FDOQ2347728

Authors: Adam A. Majewski, Giacomo Bormetti, Fulvio Corsi 

Publication date: 8 June 2015

Published in: Journal of Econometrics (Search for Journal in Brave)

Abstract: In the current literature, the analytical tractability of discrete time option pricing models is guaranteed only for rather specific types of models and pricing kernels. We propose a very general and fully analytical option pricing framework, encompassing a wide class of discrete time models featuring multiple-component structure in both volatility and leverage, and a flexible pricing kernel with multiple risk premia. Although the proposed framework is general enough to include either GARCH-type volatility, Realized Volatility or a combination of the two, in this paper we focus on realized volatility option pricing models by extending the Heterogeneous Autoregressive Gamma (HARG) model of Corsi, Fusari, La Vecchia (2012) to incorporate heterogeneous leverage structures with multiple components, while preserving closed-form solutions for option prices. Applying our analytically tractable asymmetric HARG model to a large sample of S&P 500 index options, we demonstrate its superior ability to price out-of-the-money options compared to existing benchmarks.

Full work available at URL: https://arxiv.org/abs/1404.3555

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Mathematics Subject Classification ID

Time series, auto-correlation, regression, etc. in statistics (GARCH) (62M10) Derivative securities (option pricing, hedging, etc.) (91G20) Applications of statistics to actuarial sciences and financial mathematics (62P05) Statistical methods; risk measures (91G70)

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Cited In (12)

• A new bivariate approach for modeling the interaction between stock volatility and interest rate: an application to S\&P500 returns and options
• A Stochastic Volatility Model With Realized Measures for Option Pricing
• A general framework for pricing Asian options under stochastic volatility on parallel architectures
• THE BRITTEN-JONES AND NEUBERGER SMILE-CONSISTENT WITH STOCHASTIC VOLATILITY OPTION PRICING MODEL: A FURTHER ANALYSIS
• Closed-form variance swap prices under general affine GARCH models and their continuous-time limits
• GARCH option pricing models with Meixner innovations
• Generalized Autoregressive Positive-valued Processes
• The smirk in the S\&P500 futures options prices: a linearized factor analysis
• A discrete-time hedging framework with multiple factors and fat tails: on what matters
• A realized volatility approach to option pricing with continuous and jump variance components
• Estimating the constant elasticity of variance model with data-driven Markov chain Monte Carlo methods
• Econometric analysis of financial derivatives: an overview

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