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Good Volatility, Bad Volatility and Option Pricing

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  • Bruno Feunou
  • Cédric Okou

Abstract

Advances in variance analysis permit the splitting of the total quadratic variation of a jump-diffusion process into upside and downside components. Recent studies establish that this decomposition enhances volatility predictions and highlight the upside/downside variance spread as a driver of the asymmetry in stock price distributions. To appraise the economic gain of this decomposition, we design a new and flexible option pricing model in which the underlying asset price exhibits distinct upside and downside semivariance dynamics driven by the model-free proxies of the variances. The new model outperforms common benchmarks, especially the alternative that splits the quadratic variation into diffusive and jump components.
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  • Bruno Feunou & Cédric Okou, 2017. "Good Volatility, Bad Volatility and Option Pricing," Staff Working Papers 17-52, Bank of Canada.
    • Handle: RePEc:bca:bocawp:17-52
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    References listed on IDEAS

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    6. Papantonis Ioannis & Tzavalis Elias & Agapitos Orestis & Rompolis Leonidas S., 2023. "Augmenting the Realized-GARCH: the role of signed-jumps, attenuation-biases and long-memory effects," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 27(2), pages 171-198, April.
    7. Yu, Xiaoling & Xiao, Kaitian, 2023. "COVID-19 Government restriction policy, COVID-19 vaccination and stock markets: Evidence from a global perspective," Finance Research Letters, Elsevier, vol. 53(C).
    8. Zhiyuan Pan & Yudong Wang & Li Liu, 2021. "Realized bipower variation, jump components, and option valuation," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(12), pages 1933-1958, December.
    9. Bollerslev, Tim & Patton, Andrew J. & Quaedvlieg, Rogier, 2022. "Realized semibetas: Disentangling “good” and “bad” downside risks," Journal of Financial Economics, Elsevier, vol. 144(1), pages 227-246.
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    More about this item

    Keywords

    Asset Pricing; Econometric and statistical methods;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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