A Stochastic Volatility Model with Realized Measures for Option Pricing

86 Pages Posted: 19 Jul 2016 Last revised: 26 Mar 2019

See all articles by Giacomo Bormetti

Giacomo Bormetti

University of Bologna - Department of Mathematics

Roberto Casarin

University Ca' Foscari of Venice - Department of Economics

Fulvio Corsi

University of Pisa - Department of Economics; City University London

Giulia Livieri

Scuola Normale Superiore

Date Written: March 21, 2019

Abstract

Based on the fact that realized measures of volatility are affected by measurement errors, we introduce a new family of discrete-time stochastic volatility models having two measurement equations relating both observed returns and realized measures to the latent conditional variance. A semi-analytical option pricing framework is developed for this class of models. In addition, we provide analytical filtering and smoothing recursions for the basic specification of the model, and an effective MCMC algorithm for its richer variants. The empirical analysis shows the effectiveness of filtering and smoothing realized measures in inflating the latent volatility persistence - the crucial parameter in pricing Standard and Poor's 500 Index options.

Keywords: Bayesian Inference, Monte Carlo Markov Chain, High-frequency, Realized volatility, HARG, Stochastic volatility, Option pricing

JEL Classification: C1, C11, C13, C15, C32, C58, G12, G13, G15

Suggested Citation

Bormetti, Giacomo and Casarin, Roberto and Corsi, Fulvio and Livieri, Giulia, A Stochastic Volatility Model with Realized Measures for Option Pricing (March 21, 2019). Available at SSRN: https://ssrn.com/abstract=2811304 or http://dx.doi.org/10.2139/ssrn.2811304

Giacomo Bormetti

University of Bologna - Department of Mathematics ( email )

Piazza di Porta S. Donato , 5
Bologna, Bologna 40126
Italy

Roberto Casarin

University Ca' Foscari of Venice - Department of Economics ( email )

San Giobbe 873/b
Venice, 30121
Italy
+39 030.298.91.49 (Phone)
+39 030.298.88.37 (Fax)

HOME PAGE: http://venus.unive.it/r.casarin/

Fulvio Corsi

University of Pisa - Department of Economics ( email )

via Ridolfi 10
I-56100 Pisa, PI 56100
Italy

HOME PAGE: http://people.unipi.it/fulvio_corsi/

City University London ( email )

Northampton Square
London, EC1V OHB
United Kingdom

Giulia Livieri (Contact Author)

Scuola Normale Superiore ( email )

Piazza dei Cavalieri, 7
Pisa, 56126
Italy

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