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American Option Pricing with Discrete and Continuous Time Models: An Empirical Comparison

  • Lars Stentoft

    ()

    (HEC Montréal, CIRANO, CIRPEÉ, and CREATES)

This paper considers discrete time GARCH and continuous time SV models and uses these for American option pricing. We first of all show that with a particular choice of framework the parameters of the SV models can be estimated using simple maximum likelihood techniques. Hence the two types of models can be implemented in an internally consistent manner. We then perform a Monte Carlo study to examine their differences in terms of option pricing, and we study the convergence of the discrete time option prices to their implied continuous time values. The results show that there are differences between the two models, though the discrete time GARCH prices converge quickly to the continuous time SV values. Finally, a large scale empirical analysis using individual stock options and options on an index is performed comparing the estimated prices from discrete time models to the corresponding continuous time model prices. The results show that, while the overall differences in performance are small, for the in the money put options on individual stocks the continuous time SV models do generally perform better than the discrete time GARCH specifications.

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Paper provided by Department of Economics and Business Economics, Aarhus University in its series CREATES Research Papers with number 2011-34.

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Length: 50
Date of creation: 25 Sep 2011
Date of revision:
Handle: RePEc:aah:create:2011-34
Contact details of provider: Web page: http://www.econ.au.dk/afn/

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