Advanced Search
MyIDEAS: Login to save this paper or follow this series

Simple approximations for option pricing under mean reversion and stochastic volatility

Contents:

Author Info

  • Hafner, C.M.

Abstract

This paper provides simple approximations for evaluating option prices and implied volatilities under stochastic volatility. Simple recursive formulae are derived that can easily be implemented in spreadsheets. The traditional random walk assumption, dominating in the analysis of financial markets, is compared with mean reversion which is often more relevant in commodity markets. Deterministic components in the mean and volatility are taken into consideration to allow for seasonality, another frequent aspect of commodity markets. The stochastic volatility is suitably modelled by GARCH. An application to electricity options shows that the choice between a random walk and a mean reversion model can have strong effects for predictions of implied volatilities even if the two models are statistically close to each other.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://repub.eur.nl/pub/1720/feweco20030708115600.pdf
Download Restriction: no

Bibliographic Info

Paper provided by Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute in its series Econometric Institute Research Papers with number EI 2003-20.

as in new window
Length:
Date of creation: 08 Jul 2003
Date of revision:
Handle: RePEc:ems:eureir:1720

Contact details of provider:
Postal: Postbus 1738, 3000 DR Rotterdam
Phone: 31 10 4081111
Web page: http://www.eur.nl/ese
More information through EDIRC

Related research

Keywords: derivatives; energy markets; mean reversion; seasonality; spreadsheets; stochastic volatility;

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  2. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, American Finance Association, vol. 44(5), pages 1115-53, December.
  3. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, Elsevier, vol. 31(3), pages 307-327, April.
  4. Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, American Finance Association, vol. 52(3), pages 923-73, July.
  5. Hafner, Christian M. & Herwartz, Helmut, 2001. "Option pricing under linear autoregressive dynamics, heteroskedasticity, and conditional leptokurtosis," Journal of Empirical Finance, Elsevier, Elsevier, vol. 8(1), pages 1-34, March.
  6. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "A Theory of the Term Structure of Interest Rates," Econometrica, Econometric Society, Econometric Society, vol. 53(2), pages 385-407, March.
  7. Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, American Finance Association, vol. 42(2), pages 281-300, June.
  8. Aydinli, Gökhan, 2002. "Net based spreadsheets in quantitative finance," SFB 373 Discussion Papers 2002,42, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:ems:eureir:1720. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (RePub).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.