Bayesian Forecasting of Options Prices: A Natural Framework for Pooling Historical and Implied Volatiltiy Information
Bayesian statistical methods are naturally oriented towards pooling in a rigorous way information from separate sources. It has been suggested that both historical and implied volatilities convey information about future volatility. However, typically in the literature implied and return volatility series are fed separately into models to provide rival forecasts of volatility or options prices. We develop a formal Bayesian framework where we can merge the backward looking information as represented in historical daily return data with the forward looking information as represented in implied volatilities of reported options prices. We apply our theory in forecasting the prices of FTSE 100 European Index options. We find that for forecasting options prices out of sample (i.e. one-day ahead) our Bayesian estimators outperform standard forecasts that use implied or historical volatilities. We find no evidence to suggest that standard procedures using implied volatility estimates are redundant in explaining market options prices.
|Date of creation:||Nov 2001|
|Date of revision:|
|Contact details of provider:|| Web page: http://www.econ.cam.ac.uk/index.htm|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Darsinos, T. & Satchell, S.E., 2001. "Bayesian Analysis of the Black-Scholes Option Price," Cambridge Working Papers in Economics 0102, Faculty of Economics, University of Cambridge.
- Wiggins, James B., 1987. "Option values under stochastic volatility: Theory and empirical estimates," Journal of Financial Economics, Elsevier, vol. 19(2), pages 351-372, December.
- Bauwens, L. & Lubrano, M., 2000.
"Bayesian Option Pricing using Asymmetric Garch Models,"
00a18, Universite Aix-Marseille III.
- Bauwens, Luc & Lubrano, Michel, 2002. "Bayesian option pricing using asymmetric GARCH models," Journal of Empirical Finance, Elsevier, vol. 9(3), pages 321-342, August.
- BAUWENS , Luc & LUBRANO, Michel, . "Bayesian option pricing using asymmetric GARCH models," CORE Discussion Papers RP 1569, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Bauwens, Luc & Lubrano, Michel & Richard, Jean-Francois, 2000. "Bayesian Inference in Dynamic Econometric Models," OUP Catalogue, Oxford University Press, number 9780198773139, July.
- Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley.
- Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July.
- Amin, Kaushik I. & Jarrow, Robert A., 1991. "Pricing foreign currency options under stochastic interest rates," Journal of International Money and Finance, Elsevier, vol. 10(3), pages 310-329, September.
- Baillie, R.T. & Bollerslev, R.T., 1990.
"Prediction In Dynamic Models With Time Dependent Conditional Variances,"
8815, Michigan State - Econometrics and Economic Theory.
- Baillie, Richard T. & Bollerslev, Tim, 1992. "Prediction in dynamic models with time-dependent conditional variances," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 91-113.
- Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-43.
- Jin-Chuan Duan, 1995. "The Garch Option Pricing Model," Mathematical Finance, Wiley Blackwell, vol. 5(1), pages 13-32.
- Hafner, Christian M. & Herwartz, Helmut, 2001.
"Option pricing under linear autoregressive dynamics, heteroskedasticity, and conditional leptokurtosis,"
Journal of Empirical Finance,
Elsevier, vol. 8(1), pages 1-34, March.
- Hafner, Christian M. & Herwartz, Helmut, 1999. "Option pricing under linear autoregressive dynamics, heteroskedasticity, and conditional leptokurtosis," SFB 373 Discussion Papers 1999,58, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
- Engle, Robert F. & Mustafa, Chowdhury, 1992. "Implied ARCH models from options prices," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 289-311.
- Hull, John C & White, Alan D, 1987. " The Pricing of Options on Assets with Stochastic Volatilities," Journal of Finance, American Finance Association, vol. 42(2), pages 281-300, June.
- Heston, Steven L & Nandi, Saikat, 2000. "A Closed-Form GARCH Option Valuation Model," Review of Financial Studies, Society for Financial Studies, vol. 13(3), pages 585-625.
- Scott, Louis O., 1987. "Option Pricing when the Variance Changes Randomly: Theory, Estimation, and an Application," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(04), pages 419-438, December.
- Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Karolyi, G. Andrew, 1993. "A Bayesian Approach to Modeling Stock Return Volatility for Option Valuation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(04), pages 579-594, December.
- Nelson, Daniel B., 1990. "ARCH models as diffusion approximations," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 7-38.
- David G. Hobson & L. C. G. Rogers, 1998. "Complete Models with Stochastic Volatility," Mathematical Finance, Wiley Blackwell, vol. 8(1), pages 27-48.
- Stein, Elias M & Stein, Jeremy C, 1991. "Stock Price Distributions with Stochastic Volatility: An Analytic Approach," Review of Financial Studies, Society for Financial Studies, vol. 4(4), pages 727-52.
When requesting a correction, please mention this item's handle: RePEc:cam:camdae:0116. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jake Dyer)
If references are entirely missing, you can add them using this form.