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Option pricing with non-Gaussian scaling and infinite-state switching volatility

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  • Fulvio Baldovin
  • Massimiliano Caporin
  • Michele Caraglio
  • Attilio Stella
  • Marco Zamparo

Abstract

Volatility clustering, long-range dependence, and non-Gaussian scaling are stylized facts of financial assets dynamics. They are ignored in the Black & Scholes framework, but have a relevant impact on the pricing of options written on financial assets. Using a recent model for market dynamics which adequately captures the above stylized facts, we derive closed form equations for option pricing, obtaining the Black & Scholes as a special case. By applying our pricing equations to a major equity index option dataset, we show that inclusion of stylized features in financial modeling moves derivative prices about 30% closer to the market values without the need of calibrating models parameters on available derivative prices.

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File URL: http://arxiv.org/pdf/1307.6322
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Paper provided by arXiv.org in its series Papers with number 1307.6322.

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Date of creation: Jul 2013
Date of revision: May 2014
Handle: RePEc:arx:papers:1307.6322

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