What Data Should Be Used to Price Options?

49 Pages Posted: 29 Aug 1998

See all articles by Mikhail Chernov

Mikhail Chernov

UCLA Anderson

Eric Ghysels

University of North Carolina Kenan-Flagler Business School; University of North Carolina (UNC) at Chapel Hill - Department of Economics

Date Written: July 20, 1998

Abstract

In this paper we propose a generic procedure for estimating and pricing options in the context of stochastic volatility models using simultaneously the fundamental price and a set of option contracts. We appraise univariate and multivariate estimation of the model in terms of pricing and hedging performance. Our results, based on the S&P 500 index contract, show that the univariate approach only involving options by and large dominates. A by-product of this finding is that we uncover a remarkably simple volatility extraction filter based on a polynomial lag structure of implied volatilities. The bivariate approach involving both the fundamental and an option appears useful when the information from the cash market provides support via the conditional kurtosis to price options. This is the case for some long term options. Moreover, having estimated separately the risk-neutral and objective measures allows us to appraise the typical risk-neutral representations used in the literature. Using Heston's (1993) model as example we show that the usual transformation from objective to risk neutral density is not supported by the data.

JEL Classification: G13, C14, C52, C53

Suggested Citation

Chernov, Mikhail and Ghysels, Eric, What Data Should Be Used to Price Options? (July 20, 1998). Available at SSRN: https://ssrn.com/abstract=120028 or http://dx.doi.org/10.2139/ssrn.120028

Mikhail Chernov (Contact Author)

UCLA Anderson ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Eric Ghysels

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Gardner Hall, CB 3305
Chapel Hill, NC 27599
United States
919-966-5325 (Phone)
919-966-4986 (Fax)

HOME PAGE: http://www.unc.edu/~eghysels/

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