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Unlocking the black box: Non-parametric option pricing before and during COVID-19

Author

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  • Nikola Gradojevic

    (University of Guelph, Lang School of Business and Economics
    University of Novi Sad)

  • Dragan Kukolj

    (University of Novi Sad)

Abstract

This paper addresses the interpretability problem of non-parametric option pricing models by using the explainable artificial intelligence (XAI) approach. We study call options written on the S&P 500 stock market index across three market regimes: pre-COVID-19, COVID-19 market crash, and post-COVID-19 recovery. Our comparative option pricing exercise demonstrates the superiority of the random forest and extreme gradient boosting models for each market regime. We also show that the model’s pricing accuracy has worsened from the pre-COVID-19 to the recovery period. Moneyness was the most important price determinants across the market regimes, while the implied volatility and time-to-maturity inputs contributed intermittently to a lesser extent. During the COVID-19 crash, open interest gained more economic importance due to the increased behavioral tendencies of traders consistent with market distress.

Suggested Citation

  • Nikola Gradojevic & Dragan Kukolj, 2024. "Unlocking the black box: Non-parametric option pricing before and during COVID-19," Annals of Operations Research, Springer, vol. 334(1), pages 59-82, March.
    • Handle: RePEc:spr:annopr:v:334:y:2024:i:1:d:10.1007_s10479-022-04578-7
    DOI: 10.1007/s10479-022-04578-7
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    More about this item

    Keywords

    Option pricing; COVID-19; Random forest; Extreme gradient boosting; Explainable artificial intelligence; Interpretability;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • C45 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Neural Networks and Related Topics
    • C55 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Large Data Sets: Modeling and Analysis
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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