Stochastic Volatility and Pricing Bias in the Swedish OMX-Index Call Option Market
AbstractThis 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
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Bibliographic InfoPaper provided by Lund University, Department of Economics in its series Working Papers with number 2000:16.
Length: 19 pages
Date of creation: 06 Nov 2000
Date of revision:
Contact details of provider:
Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/
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derivatives pricing; stochastic volatility; Fourier inversion;
Find related papers by JEL classification:
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-FMK-2000-11-14 (Financial Markets)
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