Abstract

http://ssrn.com/abstract=2018422
 


 



An Application of GARCH Models in Detecting Systematic Bias in Options Pricing and Determining Arbitrage in Options


Mihir Dash


Alliance University - School of Business

Jay H. Dagha


affiliation not provided to SSRN

Pooja Sharma


affiliation not provided to SSRN

Rashmi Singhal


affiliation not provided to SSRN

March 8, 2012

Journal of CENTRUM Cathedra: The Business and Economics Research Journal, Vol. 5, Issue 1, pp. 91-101, 2012

Abstract:     
Derivatives have become widely accepted as tools for hedging and risk-management, as well as speculation to some extent. A more recent trend has been gaining ground, namely, arbitrage in derivatives.

The critical parameter in derivatives pricing is the volatility of the underlying asset. Exchanges often overestimate volatility in order to cover any sudden changes in market behavior, leading to systematic overpricing of derivatives. Accurate forecasting of volatility would expose systematic overpricing. Unfortunately, volatility is not an easy phenomenon to predict or forecast. One class of models that have proved successful in forecasting volatility in many situations is the Generalized Autoregressive Conditional Heteroscedasticity (GARCH) family of models.

The objective of the present study is to analyze systematic bias in the pricing of options derivatives. In order to perform the analysis, data were collected for a sample of stock options traded on the National Stock Exchange (NSE) of India and their underlying stocks. In the study, GARCH models are used to forecast underlying stock volatility, and the forecasted volatility is used in the Black-Scholes model in order to determine whether the corresponding options were fairly priced. Any systematic bias in options pricing would provide evidence for arbitrage opportunities.

Number of Pages in PDF File: 11

Keywords: derivatives, hedging, speculation, arbitrage, volatility, overpricing, GARCH, Black-Scholes model

JEL Classification: G13

Accepted Paper Series


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Date posted: March 10, 2012 ; Last revised: October 31, 2012

Suggested Citation

Dash, Mihir and Dagha, Jay H. and Sharma, Pooja and Singhal, Rashmi, An Application of GARCH Models in Detecting Systematic Bias in Options Pricing and Determining Arbitrage in Options (March 8, 2012). Journal of CENTRUM Cathedra: The Business and Economics Research Journal, Vol. 5, Issue 1, pp. 91-101, 2012. Available at SSRN: http://ssrn.com/abstract=2018422

Contact Information

Mihir Dash (Contact Author)
Alliance University - School of Business ( email )
Chikkahagade Cross,
Chandapura-Anekal Road, Anekal
Bangalore, Karnataka 562106
India
9945182465 (Phone)
Jay H. Dagha
affiliation not provided to SSRN ( email )
Pooja Sharma
affiliation not provided to SSRN ( email )
Rashmi Singhal
affiliation not provided to SSRN ( email )
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