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Assessing Models of Individual Equity Option Prices

34 Pages Posted: 11 Apr 2012  

Gurdip Bakshi

University of Maryland - Robert H. Smith School of Business

Charles Cao

Pennsylvania State University

Zhaodong Zhong

Rutgers University

Date Written: April 9, 2012

Abstract

This article investigates option models in the encompassing class of stochastic volatility, return-jumps, and volatility-jumps. Relying on individual equity options on the 50 most active firms and maximum likelihood estimation method, we obtain several findings. First, while stochastic volatility is as important for individual equity options as it is for index options, return-jumps and volatility-jumps are also essential in pricing individual equity options. Second, the double-jump model improves pricing performance beyond return-jumps absent volatility-jumps, and beyond volatility-jumps absent return-jumps. Third, between return-jumps and volatility-jumps, the former is empirically more relevant than the latter for pricing options; and fourth, the inverse link between volatility-jumps and return-jumps is instrumental for explaining the valuation of deep out-of-money puts and the option dynamics of firms with high kurtosis.

Keywords: individual equity option-models, risk-neutral kurtosis, return-jumps, volatility-jumps, stochastic volatility, option-implied return distributions

JEL Classification: G10, G12, G13

Suggested Citation

Bakshi, Gurdip and Cao, Charles and Zhong, Zhaodong, Assessing Models of Individual Equity Option Prices (April 9, 2012). Available at SSRN: https://ssrn.com/abstract=2038551 or http://dx.doi.org/10.2139/ssrn.2038551

Gurdip S. Bakshi

University of Maryland - Robert H. Smith School of Business ( email )

Department of Finance
College Park, MD 20742-1815
United States
301-405-2261 (Phone)
301-314-9157 (Fax)

HOME PAGE: http://scholar.rhsmith.umd.edu/gbakshi/Home?destination=Home

Charles Cao

Pennsylvania State University ( email )

Department of Finance
Smeal College of Business
University Park, PA 16802
United States
814-865-7891 (Phone)
814-865-3362 (Fax)

HOME PAGE: http://www.personal.psu.edu/qxc2/cao.html

Zhaodong Zhong (Contact Author)

Rutgers University ( email )

Department of Finance, Rutgers Business School
100 Rockafeller Road
Piscataway, NJ 08854
United States

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