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Testing option pricing models: complete and incomplete markets

Author

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  • Olesia Verchenko

    (Kyiv School of Economics, Kyiv Economic Institute)

Abstract

This paper examines the empirical performance of several complete and incomplete market models of stock price dynamics using S&P 500 options and stock market data. The main contribution of this work is that it suggests and implements an empirical approach to estimating a complete model with uncertain volatility, and then judges it against other popular option pricing processes. The performance of alternative models is evaluated from four perspectives: (1) in-sample fit to stock returns data, (2) in-sample fit to options data, (3) consistency of physical and risk-neutral parameter estimates and (4) out-of-sample option pricing. Overall, the complete model with uncertain volatility is found to .t the data much better than models with constant and price-level-dependent volatilities, and the variance gamma process, and its performance is comparable to that of a stochastic volatility model.

Suggested Citation

  • Olesia Verchenko, 2011. "Testing option pricing models: complete and incomplete markets," Discussion Papers 38, Kyiv School of Economics.
    • Handle: RePEc:kse:dpaper:38
    Note: Submitted to Journal of Derivatives
    as

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    File URL: http://repec.kse.org.ua/pdf/KSE_dp38.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Option pricing; complete and incomplete markets; stochastic volatility;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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    This paper has been announced in the following NEP Reports:

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