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Option pricing for GARCH-type models with generalized hyperbolic innovations

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Abstract

In this paper, we provide a new dynamic asset pricing model for plain vanilla options and we discuss its ability to produce minimum mispricing errors on equity option books. Given the historical measure, the dynamics of assets are modeled by Garch-type models with generalized hyperbolic innovations and the pricing kernel is an exponential affine function of the state variables, we show that the risk neutral distribution is unique and implies again a generalized hyperbolic dynamics with changed parameters. We provide an empirical test for our pricing methodology on two data sets of options respectively written on the French CAC 40 and the American SP 500. Then, using our theoretical result associated with Monte Carlo simulations, we compare this approach to natural competitors in order to test its efficiency. More generally, our empirical investigations analyze the ability of specific parametric innovations to reproduce market prices in the context of an exponential affine specification of the stochastic discount factor

Suggested Citation

  • Christophe Chorro & Dominique Guegan & Florian Ielpo, 2010. "Option pricing for GARCH-type models with generalized hyperbolic innovations," Documents de travail du Centre d'Economie de la Sorbonne 10023, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    • Handle: RePEc:mse:cesdoc:10023
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    File URL: http://mse.univ-paris1.fr/pub/mse/CES2010/10023.pdf
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    1. Bouchaud,Jean-Philippe & Potters,Marc, 2003. "Theory of Financial Risk and Derivative Pricing," Cambridge Books, Cambridge University Press, number 9780521819169.
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    More about this item

    Keywords

    Generalized hyperbolic distribution; option pricing; incomplete markets; CAC 40; SP 500; GARCH-type models;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes

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