Long and Short Memory in the Risk-Neutral Pricing Process

Journal of Derivatives, Forthcoming

Posted: 28 Feb 2019 Last revised: 2 Apr 2019

See all articles by Young Shin Kim

Young Shin Kim

State University of New York, SUNY at Stony Brook University, College of Business

Danling Jiang

College of Business, Stony Brook University

Stoyan V. Stoyanov

Charles Schwab

Date Written: February 11, 2019

Abstract

The paper proposes a semimartingale approximation to a fractional Levy processes that is capable of capturing long and short memory in the stochastic process together with fat tails. We use the semimartingale process in option pricing and empirically compare its performance to other option pricing models including a stochastic volatility Levy process. We contribute to the empirical literature by being the first to report the implied Hurst index computed from observed option prices using the Levy process model. Calibrating the implied Hurst index of S&P500 option prices in a period that covers the 2008 financial crisis, we find that the risk neutral measure is characterized by a short memory in turbulent markets and a long memory in calm markets.

Keywords: Option Pricing, Long-Range Dependence, Fractional Levy Processes

JEL Classification: C13, C22, G13

Suggested Citation

Kim, Young Shin and Jiang, Danling and Stoyanov, Stoyan Veselinov, Long and Short Memory in the Risk-Neutral Pricing Process (February 11, 2019). Journal of Derivatives, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3332670

Young Shin Kim (Contact Author)

State University of New York, SUNY at Stony Brook University, College of Business ( email )

306 Harriman Hall
Stony Brook, NY 11794
United States

Danling Jiang

College of Business, Stony Brook University ( email )

306 Harriman Hall
Stony Brook, NY 11794
United States

HOME PAGE: http://sites.google.com/site/danlingjiang

Stoyan Veselinov Stoyanov

Charles Schwab ( email )

101 Montgomery Street (120K-15)
San Francisco, CA 94104
United States

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