What's Beneath the Surface? Option Pricing with Multifrequency Latent States
52 Pages Posted: 7 Nov 2012 Last revised: 17 Oct 2014
Date Written: January 18, 2013
We introduce a tractable class of non-affine price processes with multifrequency stochastic volatility and jumps. The specifications 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: Suggested Citation