An empirical study on the characterization of implied volatility and pricing in the Chinese option market

Qingqian Fan and Sixian Feng

Finance Research Letters, 2022, vol. 49, issue C

Abstract: This study investigates the problem of pricing model selection for SSE 50 ETF options in the Chinese market. Numerous studies identified a volatility smile in the implied volatility of options; thus, the BS model (BS-HV model), based on the assumption of constant volatility, was criticized. Stochastic volatility models, represented by the Heston model, have become popular owing to their ability to reflect non-constant volatility. This ability inspired us to address the controversial BS-HV model issue by combining the BS formulation with the method of generating the implied volatility surface using TPS interpolation (BS-IV model). In this study, we evaluate the pricing ability of the model from three perspectives: pricing error, volatility portrayal, and price trend prediction. We find that though the historical volatility of the BS-HV model cannot reflect the implicit information of the options market price, the longer the interval of its moving average, the smaller the pricing error of the test set. The BS-IV model can accurately predict the price trend but has the largest pricing error. The Heston model demonstrates average capability in the three aspects of volatility. Therefore, the merits of each model should be combined when pricing options, and the long-range BS-HV model should be used as a reference when pursuing small errors. The BS-IV model can be combined with the previous day's options closing price to obtain a reasonable options price if the trend prediction is important.

Keywords: SSE 50ETF options; Implied volatility surface; Volatility characterization, Pricing error (search for similar items in EconPapers)
JEL-codes: G12 G13 G15 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:49:y:2022:i:c:s1544612322003828

DOI: 10.1016/j.frl.2022.103160

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