Index-Option Pricing with Stochastic Volatility and the Value of Accurate Variance Forecasts

31 Pages Posted: 25 May 2006 Last revised: 7 Apr 2010

See all articles by Robert F. Engle

Robert F. Engle

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); New York University (NYU) - Volatility and Risk Institute

Alex Kane

University of California, San Diego (UCSD) - Graduate School of International Relations and Pacific Studies (IRPS)

Jaesun Noh

Korea Advanced Institute of Science and Technology (KAIST) - Graduate School of Finance

Date Written: November 1993

Abstract

In pricing primary-market options and in making secondary markets, financial intermediaries depend on the quality of forecasts of the variance of the underlying assets. Hence, the gain from improved pricing of options would be a measure of the value of a forecast of underlying asset returns. NYSE index returns over the period of 1968-1991 are used to suggest that pricing index options of up to 90-days maturity would be more accurate when: (1) using ARCH specifications in place of a moving average of squared returns; (2) using Hull and White's (1987) adjustment for stochastic variance in Black and Scholes's (1973) formula; (3) accounting explicitly for weekends and the slowdown of variance whenever the market is closed.

Suggested Citation

Engle, Robert F. and Kane, Alex and Noh, Jaesun, Index-Option Pricing with Stochastic Volatility and the Value of Accurate Variance Forecasts (November 1993). NBER Working Paper No. w4519, Available at SSRN: https://ssrn.com/abstract=264431

Robert F. Engle (Contact Author)

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Volatility and Risk Institute ( email )

44 West 4th Street
New York, NY 10012
United States

Alex Kane

University of California, San Diego (UCSD) - Graduate School of International Relations and Pacific Studies (IRPS) ( email )

9500 Gilman Drive
La Jolla, CA 92093-0519
United States

Jaesun Noh

Korea Advanced Institute of Science and Technology (KAIST) - Graduate School of Finance ( email )

207-43 Cheongryangri-2dong 130-722
Seoul
Korea

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