MCMC Estimation of Lvy Jump Models Using Stock and Option Prices
Iowa State University
University of Michigan - Stephen M. Ross School of Business; Cheung Kong Graduate School of Business
Martin T. Wells
Cornell University - School of Law
Mathematical Finance, Vol. 21, Issue 3, pp. 383-422, 2011
We examine the performances of several popular Lvy jump models and some of the most sophisticated affine jump-diffusion models in capturing the joint dynamics of stock and option prices. We develop efficient Markov chain Monte Carlo methods for estimating parameters and latent volatility/jump variables of the Lvy jump models using stock and option prices. We show that models with infinite-activity Lvy jumps in returns significantly outperform affine jump-diffusion models with compound Poisson jumps in returns and volatility in capturing both the physical and risk-neutral dynamics of the S&P 500 index. We also find that the variance gamma model of Madan, Carr, and Chang with stochastic volatility has the best performance among all the models we consider.
Number of Pages in PDF File: 40
Keywords: Levy processes, variance gamma model, Markov Chain Monte Carlo, option pricingAccepted Paper Series
Date posted: May 20, 2011
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