Testing option pricing models: complete and incomplete markets
AbstractThis paper examines the empirical performance of several complete and incomplete market models of stock price dynamics using S&P 500 options and stock market data. The main contribution of this work is that it suggests and implements an empirical approach to estimating a complete model with uncertain volatility, and then judges it against other popular option pricing processes. The performance of alternative models is evaluated from four perspectives: (1) in-sample fit to stock returns data, (2) in-sample fit to options data, (3) consistency of physical and risk-neutral parameter estimates and (4) out-of-sample option pricing. Overall, the complete model with uncertain volatility is found to .t the data much better than models with constant and price-level-dependent volatilities, and the variance gamma process, and its performance is comparable to that of a stochastic volatility model.
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Bibliographic InfoPaper provided by Kyiv School of Economics in its series Discussion Papers with number 38.
Date of creation: Apr 2011
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Note: Submitted to Journal of Derivatives
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Option pricing; complete and incomplete markets; stochastic volatility;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-05-07 (All new papers)
- NEP-FMK-2011-05-07 (Financial Markets)
- NEP-MST-2011-05-07 (Market Microstructure)
- NEP-ORE-2011-05-07 (Operations Research)
- NEP-RMG-2011-05-07 (Risk Management)
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