Option Pricing with Asymmetric Heteroskedastic Normal Mixture Models

Posted: 25 Sep 2010 Last revised: 15 Nov 2010

See all articles by J. V. K. Rombouts

J. V. K. Rombouts

HEC Montreal; Catholic University of Louvain (UCL) - Center for Operations Research and Econometrics (CORE); Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE); Center for Interuniversity Research and Analysis on Organization (CIRANO)

Lars Stentoft

Department of Economics, University of Western Ontario; Center for Interuniversity Research and Analysis on Organization (CIRANO); Aarhus University - CREATES

Date Written: September 24, 2010

Abstract

This paper uses asymmetric heteroskedastic normal mixture models to fit return data and to price options. The models can be estimated straightforwardly by maximum likelihood, have high statistical fit when used on S&P 500 index return data, and allow for substantial negative skewness and time varying higher order moments of the risk neutral distribution. When forecasting out-of-sample a large set of index options between 1996 and 2009, substantial improvements are found compared to several benchmark models in terms of dollar losses and the ability to explain the smirk in implied volatilities. Overall, the dollar root mean squared error of the best performing benchmark component model is 39% larger than for the mixture model. When considering the recent financial crisis this difference increases to 69%.

Keywords: Asymmetric Heteroskedastic Models, Finite Mixture Models, Option Pricing

JEL Classification: C11, C15, C22, G13

Suggested Citation

Rombouts, Jeroen and Stentoft, Lars, Option Pricing with Asymmetric Heteroskedastic Normal Mixture Models (September 24, 2010). CIRANO - Scientific Publications No. 2010s-38. Available at SSRN: https://ssrn.com/abstract=1682110 or http://dx.doi.org/10.2139/ssrn.1682110

Jeroen Rombouts (Contact Author)

HEC Montreal ( email )

3000, Chemin de la Côte-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada

Catholic University of Louvain (UCL) - Center for Operations Research and Econometrics (CORE) ( email )

34 Voie du Roman Pays
B-1348 Louvain-la-Neuve, b-1348
Belgium

Centre interuniversitaire sur le risque, les politiques économiques et l'emploi (CIRPÉE) ( email )

Pavillon De Sève
Ste-Foy, Quebec G1K 7P4
Canada

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

2020 rue University, 25th floor
Montreal H3C 3J7, Quebec
Canada

Lars Stentoft

Department of Economics, University of Western Ontario ( email )

London, Ontario N6A 5B8
Canada

Center for Interuniversity Research and Analysis on Organization (CIRANO)

2020 rue University, 25th floor
Montreal H3C 3J7, Quebec
Canada

Aarhus University - CREATES

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

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