Herding and Stochastic Volatility

33 Pages Posted: 5 Nov 2015 Last revised: 27 Mar 2017

See all articles by Walter Farkas

Walter Farkas

University of Zurich - Department of Banking and Finance; Swiss Finance Institute; ETH Zürich

Ciprian Necula

University of Zurich - Department of Banking and Finance; Bucharest University of Economic Studies, Department of Money and Banking

Boris Waelchli

University of Zurich - Department of Banking and Finance

Date Written: March 6, 2017

Abstract

In this paper we develop a one-factor non-affine stochastic volatility option pricing model where the dynamics of the underlying is endogenously determined from micro-foundations. The interaction and herding of the agents trading the underlying asset induce an amplification of the volatility of the asset over the volatility of the fundamentals. Although the model is non-affine, a closed form option pricing formula can still be derived by using a Gauss-Hermite series expansion methodology. The model is calibrated using S&P 500 index options for the period 1996-2013. When its results are compared to some benchmark models we find that the new non-affine one-factor model outperforms the affine one-factor Heston model, the non-affine one-factor log-normal model and it is competitive with the affine two-factor double Heston model.

Keywords: herding, non-affine option pricing model, Gauss-Hermite expansion

JEL Classification: G12, C61

Suggested Citation

Farkas, Walter and Necula, Ciprian and Waelchli, Boris, Herding and Stochastic Volatility (March 6, 2017). Swiss Finance Institute Research Paper No. 15-59, Available at SSRN: https://ssrn.com/abstract=2685939 or http://dx.doi.org/10.2139/ssrn.2685939

Walter Farkas

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

Schönberggasse 1
Zürich, 8001
Switzerland
+41-44-634 3953 (Phone)
+41-44-634 4345 (Fax)

HOME PAGE: http://https://people.math.ethz.ch/~farkas/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

ETH Zürich ( email )

Rämistrasse 101
ZUE F7
Zürich, 8092
Switzerland

Ciprian Necula

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

Plattenstrasse 14
Zürich, 8032
Switzerland

Bucharest University of Economic Studies, Department of Money and Banking ( email )

6, Romana Square, District 1
Bucharest, 010374
Romania

HOME PAGE: http://www.dofin.ase.ro/cipnec

Boris Waelchli (Contact Author)

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

Plattenstrasse 14
Zürich, 8032
Switzerland

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
202
Abstract Views
1,567
rank
192,293
PlumX Metrics