Volatility Estimation for Stock Index Options: A GARCH Approach

QUARTERLY REVIEW OF ECONOMICS AND FINANCE, Vol. 36 No. 4, Winter 1996

Posted: 10 Oct 1996

See all articles by Steven Freund

Steven Freund

University of Massachusetts Lowell - Department of Finance

Shin-Herng Chu

California State Polytechnic University, Pomona

Abstract

The objective of this paper is to compare the mispricing of option valuation models when alternate techniques are applied to the volatility estimation. Akgiray (1989) shows that out-of-sample forecasts of return variances of stock indices based on a GARCH model are superior predictors of the actual ex-post variances in comparison to forecasts generated using standard rolling regression methods. A second objective of this study is to examine if Akgiray's results carry over to option valuation. Although we find that the implied volatility technique results in the least mispricing, within the class of forecasts using only historic returns data, the use of GARCH models will also significantly reduce model mispricing.

JEL Classification: G13, G12

Suggested Citation

Freund, Steven and Chu, Shin-Herng, Volatility Estimation for Stock Index Options: A GARCH Approach. QUARTERLY REVIEW OF ECONOMICS AND FINANCE, Vol. 36 No. 4, Winter 1996, Available at SSRN: https://ssrn.com/abstract=7798

Steven Freund (Contact Author)

University of Massachusetts Lowell - Department of Finance ( email )

Lowell, MA 01854
United States

Shin-Herng Chu

California State Polytechnic University, Pomona

3801 W. Temple Avenue
Pomona, CA 91768
United States
909-869-4587 (Phone)
Not available (Fax)

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