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Garch Option Pricing with Implied Volatility

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  • Fofana, N'Zue F.
  • Brorsen, B. Wade

Abstract

Generalized autoregressive conditional heteroskedasticity (GARCH) provides a better ft to futures price data than the common assumption of identical independent normal distribution. GARCH option pricing models (OPM) with historical volatility have proven superior to the log-normality assumption of the Black option pricing model with historical volatility. Implied volatilities derived from GARCH OPM might therefore be expected to provide better guidance in investment decisions than those derived from the Black option pricing model. This paper estimates implied volatilities from GARCH OPM. The estimated implied volatilities are used to forecast option premia. Results are compared against forecasts of option premia using implied volatilities from Black's option pricing model. The GARCH implied volatilities are more stable than the Black implied volatilities. The GARCH option pricing model with implied volatility outperformed the Black option pricing model with implied volatility in terms of forecasting actual option premia.

Suggested Citation

  • Fofana, N'Zue F. & Brorsen, B. Wade, 1995. "Garch Option Pricing with Implied Volatility," 1981-1999 Conference Archive 285633, NCR-134/ NCCC-134 Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    • Handle: RePEc:ags:nc8191:285633
    DOI: 10.22004/ag.econ.285633
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    2. Thomas Url & Serguei Kaniovski, 2020. "The Potential Capital Requirement for a Minimum Prices Insurance Scheme for Wheat, Maize, and Rape Seed," WIFO Working Papers 601, WIFO.
    3. Shih-Feng Huang & Meihui Guo, 2014. "Model risk of the implied GARCH-normal model," Quantitative Finance, Taylor & Francis Journals, vol. 14(12), pages 2215-2224, December.
    4. K. Maris & K. Nikolopoulos & K. Giannelos & V. Assimakopoulos, 2007. "Options trading driven by volatility directional accuracy," Applied Economics, Taylor & Francis Journals, vol. 39(2), pages 253-260.
    5. Hassan Tanha & Michael Dempsey, 2016. "The Information Content of ASX SPI 200 Implied Volatility," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 19(01), pages 1-14, March.

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