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Volatility Timing: Pricing Barrier Options on DAX XETRA Index

Author

Listed:
  • Carlos Esparcia

    (School of Business and Communication, International University of La Rioja, 26006 Logroño, Spain)

  • Elena Ibañez

    (School of Economics and Business, University of Castilla-La Mancha, 02071 Albacete, Spain)

  • Francisco Jareño

    (Department of Economics and Finance, University of Castilla-La Mancha, 02071 Albacete, Spain)

Abstract

This paper analyses the impact of different volatility structures on a range of traditional option pricing models for the valuation of call down and out style barrier options. The construction of a Risk-Neutral Probability Term Structure (RNPTS) is one of the main contributions of this research, which changes in parallel with regard to the Volatility Term Structure (VTS) in the main and traditional methods of option pricing. As a complementary study, we propose the valuation of options by assuming a constant or historical volatility. The study implements the GARCH (1,1) model with regard to the continuously compound returns of the DAX XETRA Index traded at daily frequency. Current methodology allows for obtaining accuracy forecasts of the realized market barrier option premiums. The paper highlights not only the importance of selecting the right model for option pricing, but also fitting the most accurate volatility structure.

Suggested Citation

  • Carlos Esparcia & Elena Ibañez & Francisco Jareño, 2020. "Volatility Timing: Pricing Barrier Options on DAX XETRA Index," Mathematics, MDPI, vol. 8(5), pages 1-25, May.
    • Handle: RePEc:gam:jmathe:v:8:y:2020:i:5:p:722-:d:353947
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    References listed on IDEAS

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