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Stochastic Volatility and Pricing Bias in the Swedish OMX-Index Call Option Market

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  • Byström , Hans

    (Department of Economics, Lund University)

Abstract

This paper investigates the pricing bias in the Swedish OMX-Index Option market and how a stochastic volatility affects European call option prices. The market is purely European and without dividends for the period studied. A CIR square-root process for the volatility is estimated with non-linear least square minimization, and stochastic volatility option prices are calculated through Fourier-Inversion. These call option prices are compared to Black-Scholes prices as well as observed market prices, and a well-defined bias structure between Stochastic Volatility prices and Black-Scholes prices is observed. With a dynamic hedging scheme, I demonstrate larger (ex ante) profits, excluding transaction costs, for traders using the stochastic volatility model rather than the Black-Scholes model

Suggested Citation

  • Byström , Hans, 2000. "Stochastic Volatility and Pricing Bias in the Swedish OMX-Index Call Option Market," Working Papers 2000:16, Lund University, Department of Economics.
    • Handle: RePEc:hhs:lunewp:2000_016
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    More about this item

    Keywords

    derivatives pricing; stochastic volatility; Fourier inversion;
    All these keywords.

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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