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Stress Testing Option Sensitivities in a Stochastic Market

In: Advances in Longitudinal Data Methods in Applied Economic Research

Author

Listed:
  • Alexis Levendis

    (University of Johannesburg
    University of Pretoria)

  • Pierre Venter

    (University of Johannesburg
    University of Pretoria)

  • Eben Maré

    (University of Pretoria)

Abstract

The Heston stochastic volatility model aims to parameterise the equity market with 5 specific parameters. It is arguably one of the most popular models used in option pricing, since it relaxes the Black–Scholes assumption of constant volatility, and can capture the observed equity skew. Another reason for its popularity is the fact that it has an analytical solution for European options and associated option sensitivities called the Greeks. In this paper, we analyse the sensitivity of the three main option sensitivities: Delta, Gamma, and Vega, to changes in market conditions. We specifically test what happens to each option sensitivity in a bear market—as we currently face in the wake of COVID-19. We find that the option sensitivities are linked to the Heston model parameters; therefore, the Heston model parameters should give market makers an idea of future option behaviour.

Suggested Citation

  • Alexis Levendis & Pierre Venter & Eben Maré, 2021. "Stress Testing Option Sensitivities in a Stochastic Market," Springer Proceedings in Business and Economics, in: Nicholas Tsounis & Aspasia Vlachvei (ed.), Advances in Longitudinal Data Methods in Applied Economic Research, pages 431-444, Springer.
    • Handle: RePEc:spr:prbchp:978-3-030-63970-9_30
    DOI: 10.1007/978-3-030-63970-9_30
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