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Herding and Stochastic Volatility

Author

Listed:
  • Walter Farkas

    (University of Zurich, EPFL, Swiss Finance Institute and ETH Zürich)

  • Ciprian Necula

    (University of Zurich and Bucharest University of Economic Studies)

  • Boris Waelchli

    (University of Zurich)

Abstract

In this paper we develop a one-factor non-affine stochastic volatility option pricing model where the dynamics of the underlying is endogenously determined from micro-foundations. The interaction and herding of the agents trading the underlying asset induce an amplification of the volatility of the asset over the volatility of the fundamentals. Although the model is non-affine, a closed form option pricing formula can still be derived by using a Gauss-Hermite series expansion methodology. The model is calibrated using S&P 500 index options for the period 1996-2013. When its results are compared to some benchmark models we find that the new non-affine one-factor model outperforms the affine one-factor Heston model and it is competitive, especially out-of-sample, with the affine two-factor double Heston model.

Suggested Citation

  • Walter Farkas & Ciprian Necula & Boris Waelchli, 2015. "Herding and Stochastic Volatility," Swiss Finance Institute Research Paper Series 15-59, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1559
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    Cited by:

    1. Ciprian Necula & Gabriel Drimus & Walter Farkas, 2019. "A general closed form option pricing formula," Review of Derivatives Research, Springer, vol. 22(1), pages 1-40, April.

    More about this item

    Keywords

    herding; non-affine option pricing model; Gauss-Hermite expansion;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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