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http://ssrn.com/abstract=603382
 
 

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A GARCH Option Pricing Model with Filtered Historical Simulation


Giovanni Barone-Adesi


Swiss Finance Institute at the University of Lugano; Swiss Finance Institute

Robert F. Engle


New York University - Leonard N. Stern School of Business - Department of Economics; New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER)

Loriano Mancini


Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

January 2008

Review of Financial Studies, 2008

Abstract:     
We propose a new method for pricing options based on GARCH models with filtered historical innovations. In an incomplete market framework, we allow for different distributions of historical and pricing return dynamics enhancing the model flexibility to fit market option prices. An extensive empirical analysis based on S&P 500 index options shows that our model outperforms other competing GARCH pricing models and ad hoc Black-Scholes models. We show that the flexible change of measure, the asymmetric GARCH volatility and the nonparametric innovation distribution induce the accurate pricing performance of our model. Using a nonparametric approach, we obtain decreasing state price densities per unit probability as suggested by economic theory and corroborating our GARCH pricing model. Implied volatility smiles appear to be explained by asymmetric volatility and negative skewness of filtered historical innovations.

Number of Pages in PDF File: 54

Keywords: Option pricing, GARCH model, state price density, Monte Carlo simulation

JEL Classification: G13

working papers series





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Date posted: October 15, 2004 ; Last revised: April 29, 2008

Suggested Citation

Barone-Adesi, Giovanni and Engle, Robert F. and Mancini, Loriano, A GARCH Option Pricing Model with Filtered Historical Simulation (January 2008). Review of Financial Studies, 2008. Available at SSRN: http://ssrn.com/abstract=603382 or http://dx.doi.org/10.2139/ssrn.603382

Contact Information

Giovanni Barone-Adesi (Contact Author)
Swiss Finance Institute at the University of Lugano ( email )
Via Buffi 13
CH-6904 Lugano
Switzerland
+41 58 666 4671 (Phone)
+41 58 666 46 47 (Fax)
Swiss Finance Institute
c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland
Robert F. Engle
New York University - Leonard N. Stern School of Business - Department of Economics ( email )
269 Mercer Street
New York, NY 10003
United States
New York University (NYU) - Department of Finance
Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Loriano Mancini
Ecole Polytechnique Fédérale de Lausanne ( email )
Quartier UNIL-Dorigny
Bâtiment Extranef
1015 Lausanne, CH-1015
Switzerland
HOME PAGE: http://sfi.epfl.ch/mancini.html
Swiss Finance Institute ( email )
c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland
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