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Pricing FTSE 100 index options under stochastic volatility

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  • Yueh‐Neng Lin
  • Norman Strong
  • Xinzhong Xu

Abstract

The autoregressive conditional heteroscedasticity/generalized autoregressive conditional heteroscedasticity (ARCH/GARCH) literature and studies of implied volatility clearly show that volatility changes over time. This article investigates the improvement in the pricing of Financial Times‐Stock Exchange (FTSE) 100 index options when stochastic volatility is taken into account. The major tool for this analysis is Heston’s (1993) stochastic volatility option pricing formula, which allows for systematic volatility risk and arbitrary correlation between underlying returns and volatility. The results reveal significant evidence of stochastic volatility implicit in option prices, suggesting that this phenomenon is essential to improving the performance of the Black–Scholes model (Black & Scholes, 1973) for FTSE 100 index options. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:197–211, 2001

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  • Yueh‐Neng Lin & Norman Strong & Xinzhong Xu, 2001. "Pricing FTSE 100 index options under stochastic volatility," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 21(3), pages 197-211, March.
    • Handle: RePEc:wly:jfutmk:v:21:y:2001:i:3:p:197-211
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    Cited by:

    1. Rui Fan & Stephen J. Taylor & Matteo Sandri, 2018. "Density forecast comparisons for stock prices, obtained from high‐frequency returns and daily option prices," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 38(1), pages 83-103, January.
    2. Konstantinos Skindilias & Chia Lo, 2015. "Local volatility calibration during turbulent periods," Review of Quantitative Finance and Accounting, Springer, vol. 44(3), pages 425-444, April.
    3. Xiaoquan Liu, 2007. "Bid-ask spread, strike prices and risk-neutral densities," Applied Financial Economics, Taylor & Francis Journals, vol. 17(11), pages 887-900.

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