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Realizing smiles: Options pricing with realized volatility

  • Corsi, Fulvio
  • Fusari, Nicola
  • La Vecchia, Davide

We develop a discrete-time stochastic volatility option pricing model exploiting the information contained in the Realized Volatility (RV), which is used as a proxy of the unobservable log-return volatility. We model the RV dynamics by a simple and effective long-memory process, whose parameters can be easily estimated using historical data. Assuming an exponentially affine stochastic discount factor, we obtain a fully analytic change of measure. An empirical analysis of Standard and Poor's 500 index options illustrates that our model outperforms competing time-varying and stochastic volatility option pricing models.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 107 (2013)
Issue (Month): 2 ()
Pages: 284-304

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Handle: RePEc:eee:jfinec:v:107:y:2013:i:2:p:284-304
DOI: 10.1016/j.jfineco.2012.08.015
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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