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A Note on Option Pricing with the Use of Discrete-Time Stochastic Volatility Processes

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  • Anna Pajor

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    (Cracow University of Economics)

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    Abstract

    In this paper we show that in the lognormal discrete-time stochastic volatility model with predictable conditional expected returns, the conditional expected value of the discounted payoff of a European call option is infinite. Our empirical illustration shows that the characteristics of the predictive distributions of the discounted payoffs, obtained using Monte Carlo methods, do not indicate directly that the expected discounted payoffs are infinite.

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    File URL: http://cejeme.org/publishedarticles/2009-41-31-633740820660689040-8334.pdf
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    Bibliographic Info

    Article provided by CEJEME in its journal Central European Journal of Economic Modelling and Econometrics.

    Volume (Year): 1 (2009)
    Issue (Month): 1 (March)
    Pages: 71-81

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    Handle: RePEc:psc:journl:v:1:y:2009:i:1:p:71-81

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    Web page: http://cejeme.org/

    Related research

    Keywords: option pricing; SV model; Bayesian forecasting;

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    1. Mahieu, R.J. & Schotman, P.C., 1998. "An empirical application of stochastic volatility models," Open Access publications from Tilburg University urn:nbn:nl:ui:12-3131739, Tilburg University.
    2. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
    4. Jiang, G.J. & Sluis, P.J. van der, 2000. "Index Option Pricing Models with Stochastic Volatility and Stochastic Interest Rates," Discussion Paper 2000-36, Tilburg University, Center for Economic Research.
    5. Amin, Kaushik I & Ng, Victor K, 1993. " Option Valuation with Systematic Stochastic Volatility," Journal of Finance, American Finance Association, vol. 48(3), pages 881-910, July.
    6. Jacquier, Eric & Polson, Nicholas G. & Rossi, P.E.Peter E., 2004. "Bayesian analysis of stochastic volatility models with fat-tails and correlated errors," Journal of Econometrics, Elsevier, vol. 122(1), pages 185-212, September.
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