Multivariate Option Pricing Using Dynamic Copula Models

CentER Discussion Paper No. 2003-122

21 Pages Posted: 21 Jun 2004

See all articles by Rob W. J. van den Goorbergh

Rob W. J. van den Goorbergh

Tilburg University - Department of Finance

Christian Genest

Laval University - Department of Mathematics & Statistics

Bas J. M. Werker

Tilburg University - Center for Economic Research (CentER)

Date Written: 2003

Abstract

This paper examines the behavior of multivariate option prices in the presence of association between the underlying assets. Parametric families of copulas offering various alternatives to the normal dependence structure are used to model this association, which is explicitly assumed to vary over time as a function of the volatilities of the assets. These dynamic copula models are applied to better-of-two-markets and worse-of-two-markets options on the S&P500 and Nasdaq indexes. Results show that option prices implied by dynamic copula models differ substantially from prices implied by models that fix the dependence between the underlyings, particularly in times of high volatilities. Furthermore, the normal copula produces option prices that differ significantly from non-normal copula prices, irrespective of initial volatility levels. Within the class of non-normal copula families considered, option prices are robust with respect to the copula choice.

Keywords: Time-varying dependence, best-of-two-markets options, non-normality

JEL Classification: G13

Suggested Citation

van den Goorbergh, Rob W. J. and Genest, Christian and Werker, Bas J.M., Multivariate Option Pricing Using Dynamic Copula Models (2003). CentER Discussion Paper No. 2003-122, Available at SSRN: https://ssrn.com/abstract=556959 or http://dx.doi.org/10.2139/ssrn.556959

Rob W. J. Van den Goorbergh (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 8222 (Phone)

Christian Genest

Laval University - Department of Mathematics & Statistics ( email )

Quebec G1K 7P4
Canada
418-656-5280 (Phone)
418-656-2817 (Fax)

Bas J.M. Werker

Tilburg University - Center for Economic Research (CentER) ( email )

Econometrics and Finance Group
5000 LE Tilburg
Netherlands

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