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Option Valuation with Macro-Finance Variables

Journal of Financial and Quantitative Analysis, Vol. 51, No. 4, pp 1359-1389, August 2016

59 Pages Posted: 17 May 2010 Last revised: 16 Nov 2016

Christian Dorion

HEC Montreal

Date Written: December 20, 2013

Abstract

We propose a new model in which option values are determined by economic variables. Given the price of the underlying asset and its volatility, the price of an option in the model depends on macroeconomic conditions. Using an index of current business conditions as the driver, the new model outperforms existing benchmarks in fitting underlying asset returns and in the pricing of options. The model performs particularly well when business conditions are deteriorating. Using the recent financial crisis as an out-of-sample experiment, the new model has option-pricing errors that are 18% below those of a nested two-component volatility benchmark.

Keywords: Option valuation; Volatility; Macroeconomic risk; Business conditions; Mixed data sampling; GARCH

JEL Classification: C22, E32, G13

Suggested Citation

Dorion, Christian, Option Valuation with Macro-Finance Variables (December 20, 2013). Journal of Financial and Quantitative Analysis, Vol. 51, No. 4, pp 1359-1389, August 2016. Available at SSRN: https://ssrn.com/abstract=1609769 or http://dx.doi.org/10.2139/ssrn.1609769

Christian Dorion (Contact Author)

HEC Montreal ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H2X 2L3
Canada
5143401522 (Phone)
5143405632 (Fax)

HOME PAGE: http://neumann.hec.ca/pages/christian.dorion/

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