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Option Implied Tail Index and Volatility Based on Heavy-tailed Distributions: Evidence from KOSPI 200 Index Options Market

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  • Joocheol Kim
  • Hyun-Oh Kim

Abstract

This paper compares the option implied tail indexes and volatilities from two option pricing formulas based on heavy-tailed distributions: generalized extreme value (GEV) distribution and generalized logistic (GLO) distribution. Option pricing models based on heavy-tailed distributions with three parameters overcome some well-known drawbacks of the Black-Scholes model when the realized underlying asset returns are not normally distributed. Both GEV-based and GLO-based option pricing formulas extract the implied volatilities successfully, indicating that they are compatible with the Black-Scholes formulas. However, GEV-based pricing model shows more unexpected patterns when extracting the implied tail indexes for put options than GLO-based pricing model including the credit crisis in 2008, implying that GEV-based pricing model is less capable of measuring the market sentiment during the extreme crisis events.

Suggested Citation

  • Joocheol Kim & Hyun-Oh Kim, 2014. "Option Implied Tail Index and Volatility Based on Heavy-tailed Distributions: Evidence from KOSPI 200 Index Options Market," Global Economic Review, Taylor & Francis Journals, vol. 43(3), pages 269-284, September.
    • Handle: RePEc:taf:glecrv:v:43:y:2014:i:3:p:269-284
    DOI: 10.1080/1226508X.2014.941377
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