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Option pricing under GARCH models with Hansen's skewed-t distributed innovations

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  • Liu, Yanxin
  • Li, Johnny Siu-Hang
  • Ng, Andrew Cheuk-Yin

Abstract

Recently, there has been a wave of work on option pricing under GARCH-type models with non-normal innovations. However, many of the existing valuation results rely on the existence of the moment generating function of the innovations’ distribution, thereby ruling out the use of heavy-tailed distributions such as Student's t and its variants, which may better capture the excess kurtosis in historical asset returns. In this paper, we consider option pricing under GARCH models with Hansen's skewed-t distributed innovations. To overcome the limitations of the existing valuation results, we apply risk-neutralization to the empirical distribution of the simulated sample paths rather than the innovations’ parametric distribution. We illustrate our proposed method by pricing options written on the S&P 500 index.

Suggested Citation

  • Liu, Yanxin & Li, Johnny Siu-Hang & Ng, Andrew Cheuk-Yin, 2015. "Option pricing under GARCH models with Hansen's skewed-t distributed innovations," The North American Journal of Economics and Finance, Elsevier, vol. 31(C), pages 108-125.
  • Handle: RePEc:eee:ecofin:v:31:y:2015:i:c:p:108-125
    DOI: 10.1016/j.najef.2014.10.007
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    Cited by:

    1. Kim, Joseph H.T. & Li, Johnny S.H., 2017. "Risk-neutral valuation of the non-recourse protection in reverse mortgages: A case study for Korea," Emerging Markets Review, Elsevier, vol. 30(C), pages 133-154.
    2. Lin, Shin-Hung & Huang, Hung-Hsi & Li, Sheng-Han, 2015. "Option pricing under truncated Gram–Charlier expansion," The North American Journal of Economics and Finance, Elsevier, vol. 32(C), pages 77-97.

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