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Testing Option Pricing Models

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David S. Bates
Abstract

This paper discusses the commonly used methods for testing option pricing models, including the Black-Scholes, constant elasticity of variance, stochastic volatility, and jump-diffusion models. Since options are derivative assets, the central empirical issue is whether the distributions implicit in option prices are consistent with the time series properties of the underlying asset prices. Three relevant aspects of consistency are discussed, corresponding to whether time series-based inferences and option prices agree with respect to volatility, changes in volatility, and higher moments. The paper surveys the extensive empirical literature on stock options, options on stock indexes and stock index futures, and options on currencies and currency futures.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5129.

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Date of creation: May 1995
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Publication status: published as in G.S. Maddale and C.R. Rao, editers, Handbook of Statistics: Statistical Methods in Finance, Vol. 14, 1996, pp. 567-611.
Handle: RePEc:nbr:nberwo:5129

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Find related papers by JEL classification:
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

Cited by:
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  1. Eric Ghysels & Andrew Harvey & Éric Renault, 1995. "Stochastic Volatility," CIRANO Working Papers 95s-49, CIRANO. [Downloadable!]
    Other versions:
  2. Franco Molinari, 1998. "Arbitrage risk neutral probability measures," Quaderni DISA 008, Department of Computer and Management Sciences, University of Trento, Italy.
  3. Cem Aysoy & Ercan Balaban, 1996. "The Term Structure of Volatility in the Turkish Foreign Exchange : Implications for Option Pricing and Hedging Decisions," Discussion Papers 9613, Research and Monetary Policy Department, Central Bank of the Republic of Turkey. [Downloadable!]
  4. Gurdip S. Bakshi & Zhiwu Chen, . "An Alternative Model for Contingent Claims," Research in Financial Economics 9504, Ohio State University. [Downloadable!]
  5. Alessandro Beber & Luca Erzegovesi, 1999. "Distribuzioni di probabilità implicite nei prezzi delle opzioni," Alea Tech Reports 008, Department of Computer and Management Sciences, University of Trento, Italy. [Downloadable!]
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