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The Impact of Overnight Periods on Option Pricing

Author

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  • Boes, M.J.

    (Tilburg University, Center For Economic Research)

  • Drost, F.C.

    (Tilburg University, Center For Economic Research)

  • Werker, B.J.M.

    (Tilburg University, Center For Economic Research)

Abstract

This paper investigates the effect of closed overnight exchanges on option prices.During the trading day asset prices follow the literature s standard affine model which allows asset prices to exhibit stochastic volatility and random jumps.Independently, the overnight asset price process is modelled by a single jump.We find that the overnight component reduces the variation in the random jump process significantly.However, neither the random jumps nor the overnight jumps alone are able to empirically describe all features of asset prices.We conclude that both random jumps during the day and overnight jumps are important in explaining option prices, where the latter account for about one quarter of total jump risk.

Suggested Citation

  • Boes, M.J. & Drost, F.C. & Werker, B.J.M., 2005. "The Impact of Overnight Periods on Option Pricing," Discussion Paper 2005-1, Tilburg University, Center for Economic Research.
  • Handle: RePEc:tiu:tiucen:2c3a7553-f718-4caa-90f2-b8237270de05
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    References listed on IDEAS

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    1. Keim, Donald B & Stambaugh, Robert F, 1984. " A Further Investigation of the Weekend Effect in Stock Returns," Journal of Finance, American Finance Association, vol. 39(3), pages 819-835, July.
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    6. 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 327-343.
    7. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
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    9. Panigirtzoglou, Nikolaos & Skiadopoulos, George, 2004. "A new approach to modeling the dynamics of implied distributions: Theory and evidence from the S&P 500 options," Journal of Banking & Finance, Elsevier, vol. 28(7), pages 1499-1520, July.
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    Cited by:

    1. Entrop, Oliver & Scholz, Hendrik & Wilkens, Marco, 2009. "The price-setting behavior of banks: An analysis of open-end leverage certificates on the German market," Journal of Banking & Finance, Elsevier, vol. 33(5), pages 874-882, May.
    2. Kaplanski, Guy & Levy, Haim, 2015. "Trading breaks and asymmetric information: The option markets," Journal of Banking & Finance, Elsevier, vol. 58(C), pages 390-404.
    3. Kuttu, Saint & Aboagye, Anthony Q.Q. & Bokpin, Godfred A., 2018. "Evidence of time-varying conditional discrete jump dynamics in sub-Saharan African foreign exchange markets," Research in International Business and Finance, Elsevier, vol. 46(C), pages 211-226.
    4. Piccotti, Louis R., 2018. "Jumps, cojumps, and efficiency in the spot foreign exchange market," Journal of Banking & Finance, Elsevier, vol. 87(C), pages 49-67.
    5. Tsiakas, Ilias, 2008. "Overnight information and stochastic volatility: A study of European and US stock exchanges," Journal of Banking & Finance, Elsevier, vol. 32(2), pages 251-268, February.
    6. Ally Quan Zhang & Matthias Thul, 2017. "How much is the gap?—Efficient jump risk-adjusted valuation of leveraged certificates," Quantitative Finance, Taylor & Francis Journals, vol. 17(9), pages 1387-1401, September.
    7. Ito, Ryoko, 2013. "Modeling Dynamic Diurnal Patterns in High-Frequency Financial Data," Cambridge Working Papers in Economics 1315, Faculty of Economics, University of Cambridge.
    8. Nicholas Taylor, 2008. "The predictive value of temporally disaggregated volatility: evidence from index futures markets," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 27(8), pages 721-742.
    9. Ahoniemi, Katja & Lanne, Markku, 2013. "Overnight stock returns and realized volatility," International Journal of Forecasting, Elsevier, vol. 29(4), pages 592-604.

    More about this item

    Keywords

    Derivative pricing; Jump diffusion; Stochastic volatility;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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