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Option Valuation with Observable Volatility and Jump Dynamics

Author

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  • Peter Christoffersen

    () (University of Toronto, Rotman School of Management and CREATES)

  • Bruno Feunou

    () (Bank of Canada)

  • Yoontae Jeon

    () (University of Toronto, Rotman School of Management)

Abstract

Under very general conditions, the total quadratic variation of a jump-diffusion process can be decomposed into diffusive volatility and squared jump variation. We use this result to develop a new option valuation model in which the underlying asset price exhibits volatility and jump intensity dynamics. The volatility and jump intensity dynamics in the model are directly driven by model-free empirical measures of diffusive volatility and jump variation. Because the empirical measures are observed in discrete intervals, our option valuation model is cast in discrete time, allowing for straightforward filtering and estimation of the model. Our model belongs to the affine class enabling us to derive the conditional characteristic function so that option values can be computed rapidly without simulation. When estimated on S&P500 index options and returns the new model performs well compared with standard benchmarks.

Suggested Citation

  • Peter Christoffersen & Bruno Feunou & Yoontae Jeon, 2014. "Option Valuation with Observable Volatility and Jump Dynamics," CREATES Research Papers 2015-07, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:create:2015-07
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Bruno Feunou & Cédric Okou, 2017. "Good Volatility, Bad Volatility and Option Pricing," Staff Working Papers 17-52, Bank of Canada.
    2. repec:gam:jijfss:v:4:y:2016:i:1:p:3:d:63997 is not listed on IDEAS
    3. Yipeng Yang & Allanus Tsoi, 2016. "A Level Set Analysis and A Nonparametric Regression on S&P 500 Daily Return," International Journal of Financial Studies, MDPI, Open Access Journal, vol. 4(1), pages 1-24, February.

    More about this item

    Keywords

    Dynamic volatility; dynamic jumps; realized volatility; realized jumps;

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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