SSRN-American Options with Stochastic Dividends and Volatility: A Nonparametric Investigation by Mark Broadie, Jerome Detemple, Eric Ghysels, Olivier Torres

  Paper Stats:
   Abstract Views: 818
   Downloads: 0

American Options with Stochastic Dividends and Volatility: A Nonparametric Investigation

MARK BROADIE
Columbia Business School
JEROME DETEMPLE
Boston University - Department of Finance & Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO)
ERIC GHYSELS
University of North Carolina at Chapel Hill - Department of Economics
OLIVIER TORRES
Universite Catholique de Louvain

Undated

Abstract:
In this paper, we consider American option contracts when the underlying asset has stochastic dividends and stochastic volatility. We provide a full discussion of the theoretical foundations of American option valuation and exercise boundaries. We show how they depend on the various sources of uncertainty which drive dividend rates and volatility, and derive equilibrium asset prices, derivative prices and optimal exercise boundaries in a general equilibrium model. The theoretical models yield fairly complex expressions which are difficult to estimate. We therefore adopt a nonparametric approach which enables us to investigate reduced forms. Indeed, we use nonparametric methods to estimate call prices and exercise boundaries conditional on dividends and volatility. Since the latter is a latent process, we propose several approaches, notably using EGARCH filtered estimates, implied and historical volatilities. The nonparametric approach allows us to test whether call prices and exercise decisions are primarily driven by dividends, as has been advocated by Harvey and Whaley (1992a,b) and Fleming and Whaley (1994) for the OEX contract, or whether stochastic volatility complements dividend uncertainty. We find that dividends alone do not account for all aspects of call option pricing and exercise decisions, suggesting a need to include stochastic volatility.

JEL Classifications: G10, G13

Working Paper Series

Contact Information for MARK BROADIE (Contact Author) Email address for MARK BROADIE Columbia Business School 3022 Broadway 415 Uris Hall, Dept. of Management Science New York , NY 10027 United States 212-854-4103 (Phone) 212-316-9180 (Fax)
Contact Information for JEROME DETEMPLE Email address for JEROME DETEMPLE Boston University - Department of Finance & Economics 595 Commonwealth Avenue Boston , MA 02215 United States (617) 353-4297 (Phone) (617) 353 6667 (Fax)
(No e-mail address available for JEROME DETEMPLE Center for Interuniversity Research and Analysis on Organization (CIRANO) 2020 rue University, 25th Floor Montreal ,Quebec H3C 3J7 Canada
Contact Information for ERIC GHYSELS Email address for ERIC GHYSELS University of North Carolina at Chapel Hill - Department of Economics Gardner Hall, CB 3305 Chapel Hill , NC 27599 United States 919-966-5325 (Phone) 919-966-4986 (Fax)
Contact Information for OLIVIER TORRES Email address for OLIVIER TORRES Universite Catholique de Louvain Place Montesquieu, 3 B-1348 Louvain-la-Neuve Belgium

Email Abstract or URL

SSRN Resources

To search for other abstracts in the SSRN archival database, click here.

To order a membership to an SSRN Network or to subscribe to one or more of SSRN's journals, go to our online subscription request form.

To go to SSRN's main web site (www.ssrn.com), click here.