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An empirical comparison of the performance of alternative option pricing models

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  • Eva Ferreira

    (Universidad del País Vasco)

  • Mónica Gago

    (Universidad de Mondragón)

  • Angel León

    (Universidad de Alicante)

  • Gonzalo Rubio

    (Universidad del País Vasco)

Abstract

This paper presents a comparison of alternative option pricing models based either on jump-diffusion nor stochastic volatility data generating processes. We assume either a smooth volatility function of some previously defined explanatory variables or a model in which discrete-based observations can be employed to estimate both path-dependence volatility and the negative correlation between volatility and underlying returns. Moreover, we also allow for liquidity frictions to recognize that underlying markets may not be fully integrated. The simplest models tend to present a superior out-of sample performance and a better hedging ability, although the model with liquidity costs seems to display better in-sample behavior. However, none of the models seems to be able to capture the rapidly changing distribution of the underlying index return or the net buying pressure characterizing option markets.

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Bibliographic Info

Article provided by Fundación SEPI in its journal Investigaciones Economicas.

Volume (Year): 29 (2005)
Issue (Month): 3 (September)
Pages: 483-523

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Handle: RePEc:iec:inveco:v:29:y:2005:i:3:p:483-523

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Keywords: pricing; conditional volatility; hedging; liquidity; net buying pressure.;

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References

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Cited by:
  1. Ryszard Kokoszczyński & Natalia Nehrebecka & Paweł Sakowski & Paweł Strawiński & Robert Ślepaczuk, 2010. "Option Pricing Models with HF Data – a Comparative Study. The Properties of Black Model with Different Volatility Measures," Working Papers 2010-03, Faculty of Economic Sciences, University of Warsaw.

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