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.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
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:
Contact details of provider:
Postal: Department of Economics and Related Studies, University of York, York, YO10 5DD, United Kingdom
Phone: (0)1904 323776
Fax: (0)1904 323759
Web page: http://www.york.ac.uk/economics/
More information through EDIRC
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
This paper has been announced in the following NEP Reports:
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Christoffersen, Peter & Jacobs, Kris, 2004.
"The importance of the loss function in option valuation,"
Journal of Financial Economics,
Elsevier, vol. 72(2), pages 291-318, May.
- Peter Christoffersen & Kris Jacobs, 2003. "The Importance of the Loss Function in Option Valuation," CIRANO Working Papers 2003s-52, CIRANO.
- Gallant, A Ronald & Rossi, Peter E & Tauchen, George, 1992. "Stock Prices and Volume," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 199-242.
- Campbell, John Y., 1999.
"Asset prices, consumption, and the business cycle,"
Handbook of Macroeconomics,
in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 19, pages 1231-1303
- MacBeth, James D & Merville, Larry J, 1979. "An Empirical Examination of the Black-Scholes Call Option Pricing Model," Journal of Finance, American Finance Association, vol. 34(5), pages 1173-86, December.
- Bates, David S, 1996. "Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutsche Mark Options," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 69-107.
- Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
- Darrell Duffie & Jun Pan & Kenneth Singleton, 1999.
"Transform Analysis and Asset Pricing for Affine Jump-Diffusions,"
NBER Working Papers
7105, National Bureau of Economic Research, Inc.
- Darrell Duffie & Jun Pan & Kenneth Singleton, 2000. "Transform Analysis and Asset Pricing for Affine Jump-Diffusions," Econometrica, Econometric Society, vol. 68(6), pages 1343-1376, November.
- Lamoureux, Christopher G & Lastrapes, William D, 1990. " Heteroskedasticity in Stock Return Data: Volume versus GARCH Effects," Journal of Finance, American Finance Association, vol. 45(1), pages 221-29, March.
- Tim Bollerslev, 1986.
"Generalized autoregressive conditional heteroskedasticity,"
EERI Research Paper Series
EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
- Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
- Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, vol. 41(1), pages 135-55, January.
- Merton, Robert C., 1976.
"Option pricing when underlying stock returns are discontinuous,"
Journal of Financial Economics,
Elsevier, vol. 3(1-2), pages 125-144.
- Merton, Robert C., 1975. "Option pricing when underlying stock returns are discontinuous," Working papers 787-75., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Tauchen, George E & Pitts, Mark, 1983. "The Price Variability-Volume Relationship on Speculative Markets," Econometrica, Econometric Society, vol. 51(2), pages 485-505, March.
- Sheikh, Aamir M, 1993. "The Behavior of Volatility Expectations and Their Effects on Expected Returns," The Journal of Business, University of Chicago Press, vol. 66(1), pages 93-116, January.
- Campbell, John Y & Grossman, Sanford J & Wang, Jiang, 1993.
"Trading Volume and Serial Correlation in Stock Returns,"
The Quarterly Journal of Economics,
MIT Press, vol. 108(4), pages 905-39, November.
- John Y. Campbell & Sanford J. Grossman & Jiang Wang, 1992. "Trading Volume and Serial Correlation in Stock Returns," NBER Working Papers 4193, National Bureau of Economic Research, Inc.
- Wang, Jiang & Grossman, Sanford & Campbell, John, 1993. "Trading Volume and Serial Correlation in Stock Returns," Scholarly Articles 3128710, Harvard University Department of Economics.
- Allan Timmerman & Massimo Guidolin, 2001. "Option prices and implied volatility dynamics under Bayesian learning," CeNDEF Workshop Papers, January 2001 P3, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
- Epps, Thomas W, 1975. "Security Price Changes and Transaction Volumes: Theory and Evidence," American Economic Review, American Economic Association, vol. 65(4), pages 586-97, September.
- Wang, Jiang, 1994. "A Model of Competitive Stock Trading Volume," Journal of Political Economy, University of Chicago Press, vol. 102(1), pages 127-68, February.
- Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
- Shalen, Catherine T, 1993. "Volume, Volatility, and the Dispersion of Beliefs," Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 405-34.
- Das, Sanjiv Ranjan & Sundaram, Rangarajan K., 1999.
"Of Smiles and Smirks: A Term Structure Perspective,"
Journal of Financial and Quantitative Analysis,
Cambridge University Press, vol. 34(02), pages 211-239, June.
- Sanjiv R. Das & Rangarajan K. Sundaram, 1998. "Of Smiles and Smirks: A Term-Structure Perspective," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-024, New York University, Leonard N. Stern School of Business-.
- Karpoff, Jonathan M., 1987. "The Relation between Price Changes and Trading Volume: A Survey," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(01), pages 109-126, March.
- Singleton, Kenneth J., 2001. "Estimation of affine asset pricing models using the empirical characteristic function," Journal of Econometrics, Elsevier, vol. 102(1), pages 111-141, May.
- Copeland, Thomas E, 1976. "A Model of Asset Trading under the Assumption of Sequential Information Arrival," Journal of Finance, American Finance Association, vol. 31(4), pages 1149-68, September.
- Xu, Xinzhong & Taylor, Stephen J., 1994. "The Term Structure of Volatility Implied by Foreign Exchange Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(01), pages 57-74, March.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Paul Hodgson).
If references are entirely missing, you can add them using this form.