Empirical Performance of Models for Valuation and Risk-Management of Barrier Options

12 Pages Posted: 17 Feb 2009

See all articles by Cathrine Jessen

Cathrine Jessen

Copenhagen Business School - Department of Finance

Rolf Poulsen

University of Copenhagen - Department of Statistics and Operations Research

Date Written: February 17, 2009

Abstract

In this paper the empirical performance of alternative models for barrier option valuation and risk management is studied. Five commonly used models are compared: the Black-Scholes model, the constant elasticity of variance model, the Heston stochastic volatility model, the Merton jump-diffusion model, and the infinite activity Variance Gamma model. We employ time-series data from the USD/EUR exchange rate market, and use plain vanilla option prices as well as a unique data-set of observed market values of barrier options. The different models are calibrated to the plain vanilla option prices, and cross-sectional and predicted pricing errors for both plain vanilla and barrier options are investigated. For the plain vanilla options the Heston model has superior performance both in cross-section and for prediction horizons of up to one month, with its closest competitors being the Merton and the Variance Gamma models. For the barrier options, the Heston model has a slightly, but not significantly, better performance than the continuous alternatives Black-Scholes and constant elasticity of variance, while both models with jumps(Merton and Variance Gamma) perform markedly worse.

Keywords: Barrier options, risk-management, valuation, empirical performance

JEL Classification: G12

Suggested Citation

Jessen, Cathrine and Poulsen, Rolf, Empirical Performance of Models for Valuation and Risk-Management of Barrier Options (February 17, 2009). Available at SSRN: https://ssrn.com/abstract=1344924 or http://dx.doi.org/10.2139/ssrn.1344924

Cathrine Jessen (Contact Author)

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

Rolf Poulsen

University of Copenhagen - Department of Statistics and Operations Research ( email )

Universitetsparken 5
DK-2100
Denmark
+45 (353) 20685 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
302
Abstract Views
1,397
rank
102,373
PlumX Metrics