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Analytical Comparisons of Option prices in Stochastic Volatility Models

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  • Vicky Henderson

Abstract

This paper orders option prices under various well known martingale measures in an incomplete stochastic volatility model. The central result is a comparison theorem which proves convex option prices are decreasing in the market price of volatility risk, the parameter governing the choice of pricing measure. The theorem is applied to order option prices under the minimal martingale, q-optimal and minimal entropy measures. This ordering depends on the mean variance tradeoff process whilst the specifics of the volatility dynamics are not important. We illustrate our results by analyzing the Hull and White, Heston and Stein and Stein models.

Suggested Citation

  • Vicky Henderson, 2002. "Analytical Comparisons of Option prices in Stochastic Volatility Models," OFRC Working Papers Series 2002mf03, Oxford Financial Research Centre.
    • Handle: RePEc:sbs:wpsefe:2002mf03
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    File URL: http://www.finance.ox.ac.uk/file_links/finecon_papers/2002mf03.pdf
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    References listed on IDEAS

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    1. Gurdip Bakshi & Nikunj Kapadia, 2003. "Delta-Hedged Gains and the Negative Market Volatility Risk Premium," Review of Financial Studies, Society for Financial Studies, vol. 16(2), pages 527-566.
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    6. Martin Schweizer & HuyËn Pham & (*), Thorsten RheinlÄnder, 1998. "Mean-variance hedging for continuous processes: New proofs and examples," Finance and Stochastics, Springer, vol. 2(2), pages 173-198.
    7. David Heath & Eckhard Platen & Martin Schweizer, 2001. "A Comparison of Two Quadratic Approaches to Hedging in Incomplete Markets," Mathematical Finance, Wiley Blackwell, vol. 11(4), pages 385-413, October.
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    Cited by:

    1. David Hobson, 2004. "STOCHASTIC VOLATILITY MODELS, CORRELATION, AND THE q‐OPTIMAL MEASURE," Mathematical Finance, Wiley Blackwell, vol. 14(4), pages 537-556, October.
    2. Thierry Chauveau & Hayette Gatfaoui, 2004. "Pricing and Hedging Options in Incomplete Markets: Idiosyncratic Risk, Systematic Risk and Stochastic Volatility," Research Paper Series 122, Quantitative Finance Research Centre, University of Technology, Sydney.
    3. Vicky Henderson & David Hobson & Sam Howison & Tino Kluge, 2003. "A Comparison of q-optimal Option Prices in a Stochastic Volatility Model with Correlation," OFRC Working Papers Series 2003mf02, Oxford Financial Research Centre.

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