Generalized Parameter Functions for Option Pricing

Journal of Banking & Finance, Volume 34, Issue 3, March 2010, Pages 633-646

Posted: 17 Mar 2008 Last revised: 19 Jul 2015

See all articles by Christakis Charalambous

Christakis Charalambous

University of Cyprus - Department of Public and Business Administration

Panayiotis C. Andreou

Cyprus University of Technology

Spiros Martzoukos

University of Cyprus - Department of Public and Business Administration; George Washington University - School of Business

Date Written: November 3, 2008

Abstract

We extend the benchmark nonlinear deterministic volatility regression functions of Dumas et al. (1998) to provide a semi-parametric method where an enhancement of the implied parameter values is used in the parametric option pricing models. Besides volatility, skewness and kurtosis of the asset return distribution can also be enhanced. Empirical results, using closing prices of the S&P 500 index call options (in one day ahead out-of-sample pricing tests), strongly support our method that compares favorably with a model that admits stochastic volatility and random jumps. Moreover, it is found to be superior in various robustness tests. Our semi-parametric approach is an effective remedy to the curse of dimensionality presented in nonparametric estimation and its main advantage is that it delivers theoretically consistent option prices and hedging parameters. The economic significance of the approach is tested in terms of hedging, where the evaluation and estimation loss functions are aligned.

Keywords: implied parameters, deterministic volatility functions, hedging, semi-parametric approach

JEL Classification: G13, G14

Suggested Citation

Charalambous, Christakis and Andreou, Panayiotis C. and Martzoukos, Spiros Harilaos Spiridon, Generalized Parameter Functions for Option Pricing (November 3, 2008). Journal of Banking & Finance, Volume 34, Issue 3, March 2010, Pages 633-646. Available at SSRN: https://ssrn.com/abstract=1099493

Christakis Charalambous

University of Cyprus - Department of Public and Business Administration ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
CYPRUS
00357-2-892258 (Phone)
00357-2-339063 (Fax)

Panayiotis C. Andreou (Contact Author)

Cyprus University of Technology ( email )

School Of Management and Economics
P.O. Box 50329
Lemesos, 3036
Cyprus

HOME PAGE: http://www.pandreou.com

Spiros Harilaos Spiridon Martzoukos

University of Cyprus - Department of Public and Business Administration ( email )

75 Kallipoleos Street
P.O. Box 20537
Nicosia CY-1678
CYPRUS
357-2-892474 (Phone)
357-2-892460 (Fax)

George Washington University - School of Business

Washington, DC 20052
United States
202-994-5996 (Phone)
202-994-5014 (Fax)

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