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Option Pricing with Asymmetric Heteroskedastic Normal Mixture Models

Listed author(s):
  • Jeroen V.K. Rombouts

    ()

    (Institute of Applied Economics at HEC Montréal, CIRANO, CIRPEE, Université catholique de Louvain (CORE))

  • Lars Stentoft

    ()

    (Department of Finance at HEC Montréal, CIRANO, CIRPEE and CREATES)

This paper uses asymmetric heteroskedastic normal mixture models to fit return data and to price options. The models can be estimated straightforwardly by maximum likelihood, have high statistical fit when used on S&P 500 index return data, and allow for substantial negative skewness and time varying higher order moments of the risk neutral distribution. When forecasting out-of-sample a large set of index options between 1996 and 2009, substantial improvements are found compared to several benchmark models in terms of dollar losses and the ability to explain the smirk in implied volatilities. Overall, the dollar root mean squared error of the best performing benchmark component model is 39% larger than for the mixture model. When considering the recent financial crisis this difference increases to 69%.

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File URL: ftp://ftp.econ.au.dk/creates/rp/10/rp10_44.pdf
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Paper provided by Department of Economics and Business Economics, Aarhus University in its series CREATES Research Papers with number 2010-44.

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Length: 46
Date of creation: 24 Aug 2010
Handle: RePEc:aah:create:2010-44
Contact details of provider: Web page: http://www.econ.au.dk/afn/

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