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Estimating expectations of shocks using option prices

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  • Antonio Di Cesare

    ()
    (Banca d'Italia)

Abstract

The jump-diffusion model introduced by Merton is used to price a cross- section of options at different dates. At any point in time, the parameters of the model are estimated by minimizing the sum of squared implied volatility errors, and their informational content is compared with the widely used Black and Scholes implied volatility, calculated on at-the-money options. While in normal conditions the parameters of Merton's model do not seem to provide any additional information, in periods of high variability of asset prices the jump-diffusion approach may help to disentangle the cases in which volatility reflects only uncertainty on economic fundamentals from those in which it is fuelled by fears of ¯nancial crisis.

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Bibliographic Info

Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 506.

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Date of creation: Jul 2004
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Handle: RePEc:bdi:wptemi:td_506_04

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Keywords: jump-diffusion stochastic processes; option pricing; volatility;

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