Tests of the Stochastic Volatility with Jumps Model Driven by Moment Swaps
International Research Journal of Finance and Economics, Issue 176, November 2019.
18 Pages Posted: 22 Nov 2019
Date Written: November 12, 2019
This paper tests the pricing accuracy and the hedging performance of the stochastic volatility with random jumps model in markets extended to contain swap contracts whose payoffs depend on the realized higher moments of the state variable. Using a two-step iterative approach, latent model variables are first filtered and then used to estimate the model parameters. The tests on European options and variance swaps written on the S&P 500 index show superior pricing accuracies in-sample and out-of-sample and jump risk is priced. Hedging strategies involving higher-order moment swaps perform better across all moneyness and maturity classes.
Keywords: Stochastic volatility; Random jumps; Variance swaps; Higher-order moment swaps; Self-financing portfolio
JEL Classification: C52, G12, G13
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