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GARCH option pricing with volatility derivatives

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  • Oh, Dong Hwan
  • Park, Yang-Ho

Abstract

This paper studies benefits of joint estimations for GARCH option pricing that utilize both stock returns and volatility derivatives. The proposed estimations not only provide realistic volatility term structures but also generate flat skewness term structures much like those seen in the S&P 500 index (SPX) options data. In particular, the estimated GARCH models yield a highly persistent volatility component, which allows the leverage effect to hold up until long horizons. Such a persistent volatility component is key to modeling long-term tail risk and pricing long-term put options. Overall, our exercise highlights the usefulness of volatility derivatives in GARCH option valuation.

Suggested Citation

  • Oh, Dong Hwan & Park, Yang-Ho, 2023. "GARCH option pricing with volatility derivatives," Journal of Banking & Finance, Elsevier, vol. 146(C).
    • Handle: RePEc:eee:jbfina:v:146:y:2023:i:c:s0378426622002989
    DOI: 10.1016/j.jbankfin.2022.106718
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    2. Wu, Xinyu & Zhao, An & Liu, Li, 2023. "Forecasting VIX using two-component realized EGARCH model," The North American Journal of Economics and Finance, Elsevier, vol. 67(C).

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    More about this item

    Keywords

    GARCH; Option valuation; VIX Derivatives; Volatility persistence;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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