Option Pricing under Stochastic Volatility and Trading Volume
AbstractThis paper presents a pricing formula for European options derived from a model in which changes in the underlying price and trading volumes are jointly determined by exogenous events. This specification makes increments to the volatility depend on the current level of volatility and news and thereby accounts for the observed persistence in volatility. Moreover, it makes volatility an observable variable. The model accounts well for time varying volatility smiles and term structures, and that out-of-sample price forecasts for a sample of call options are superior to the benchmark ad hoc procedure of plugging implicit volatilities into the Black-Scholes formula.
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Bibliographic InfoPaper provided by Department of Economics, University of York in its series Discussion Papers with number 07/05.
Date of creation: Mar 2007
Date of revision:
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Option valuation; trading volume; the stochastic volatility and volume (SVV) model;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
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