Extracting Latent States from High Frequency Option Prices
76 Pages Posted: 30 May 2017
Date Written: May 26, 2017
We propose the realized option variance as a new observable variable to integrate high frequency option prices in the inference of option pricing models. Using simulation and empirical studies, this paper documents the incremental information offered by this realized measure. Our empirical results show that the information contained in the realized option variance improves the inference of model variables such as the instantaneous variance and variance jumps of the S&P 500 index. Parameter estimates indicate that the risk premium breakdown between jump and diffusive risks is affected by the omission of this information.
Keywords: High frequency data, realized option variance, options, jump-diffusions, particle filter
JEL Classification: C52, C55, C58, C63
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