What's Beneath the Surface? Option Pricing with Multifrequency Latent States

52 Pages Posted: 7 Nov 2012 Last revised: 17 Oct 2014

See all articles by Laurent E. Calvet

Laurent E. Calvet

EDHEC Business School - Department of Economics & Finance; CEPR

Marcus Fearnley

HEC Paris - Department of Finance

Adlai J. Fisher

University of British Columbia (UBC) - Sauder School of Business

Markus Leippold

University of Zurich - Department of Banking and Finance; University of Zurich - Faculty of Economics, Business Administration and Information Technology

Date Written: January 18, 2013

Abstract

We introduce a tractable class of non-affine price processes with multifrequency stochastic volatility and jumps. The specifi cations require few fixed parameters and deliver fast option pricing. One key ingredient is a tight link between jumps and volatility regimes, as asset pricing theory suggests. Empirically, the model matches implied volatility surfaces and their dynamics without requiring parameter recalibration. A variety of metrics show improvements over traditional benchmarks in- and out-of-sample.

Keywords: Markov-switching multifractal, particle filter, regime-switching, stochastic volatility, jump-risk premium, option pricing

JEL Classification: C51, G12, G13

Suggested Citation

Calvet, Laurent E. and Fearnley, Marcus and Fisher, Adlai J. and Leippold, Markus, What's Beneath the Surface? Option Pricing with Multifrequency Latent States (January 18, 2013). HEC Paris Research Paper No. 969/2013. Available at SSRN: https://ssrn.com/abstract=2171734 or http://dx.doi.org/10.2139/ssrn.2171734

Laurent E. Calvet

EDHEC Business School - Department of Economics & Finance ( email )

France

CEPR ( email )

33 Great Sutton Street
London, EC1V 0DX
United Kingdom

Marcus Fearnley

HEC Paris - Department of Finance ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

Adlai J. Fisher

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8331 (Phone)
604-822-4695 (Fax)

HOME PAGE: http://finance.sauder.ubc.ca/~fisher

Markus Leippold (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

University of Zurich - Faculty of Economics, Business Administration and Information Technology ( email )

Plattenstrasse 14
Zürich, 8032
Switzerland

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