Testing Option Pricing Models: Complete and Incomplete Markets

59 Pages Posted: 27 Apr 2011 Last revised: 29 Apr 2011

See all articles by Olesia Verchenko

Olesia Verchenko

Kyiv Economics Institute (KEI); Kyiv School of Economics

Date Written: August 26, 2010

Abstract

This paper examines the empirical performance of several complete and incomplete market models of stock price dynamics using S&P 500 options and stock market data. The main contribution of this work is that it suggests and implements an empirical approach to estimating a complete model with uncertain volatility, and then judges it against other popular option pricing processes. The performance of alternative models is evaluated from four perspectives: (1) in-sample fit to stock returns data, (2) in-sample fit to options data, (3) consistency of physical and risk-neutral parameter estimates and (4) out-of-sample option pricing. Overall, the complete model with uncertain volatility is found to fit the data much better than models with constant and price-level-dependent volatilities, and the variance gamma process, and its performance is comparable to that of a stochastic volatility model.

Keywords: option pricing, complete and incomplete markets, stochastic volatility

JEL Classification: G13

Suggested Citation

Verchenko, Olesia, Testing Option Pricing Models: Complete and Incomplete Markets (August 26, 2010). Available at SSRN: https://ssrn.com/abstract=1823449 or http://dx.doi.org/10.2139/ssrn.1823449

Olesia Verchenko (Contact Author)

Kyiv Economics Institute (KEI) ( email )

Kyiv, 04119
Ukraine

Kyiv School of Economics ( email )

vul. Yakira, 13, 3d floor, suite 334
Kyiv, 04119
Ukraine

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