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Specification Analysis of Option Pricing Models Based on Time-Changed Lévy Processes

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  • Jing-zhi Huang

    (Smeal College of Business, Penn State University)

  • Liuren Wu

    (Zicklin School of Business, Baruch College (CUNY))

Abstract

We analyze the specifications of option pricing models based on time-changed Lévy processes. We classify option pricing models based on the structure of the jump component in the underlying return process, the source of stochastic volatility, and the specification of the volatility process itself. Our estimation of a variety of model specifications indicates that to better capture the behavior of the S&P 500 index options, we need to incorporate a high frequency jump component in the return process and generate stochastic volatilities from two different sources, the jump component and the diffusion component. Copyright 2004 by The American Finance Association.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 59 (2004)
Issue (Month): 3 (06)
Pages: 1405-1440

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Handle: RePEc:bla:jfinan:v:59:y:2004:i:3:p:1405-1440

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