Pricing Nikkei 225 Options Using Realized Volatility

Masato Ubukata and Toshiaki Watanabe
Additional contact information
Masato Ubukata: Assistant Professor, Department of Economics, Kushiro Public University of Economics (E-mail: ubukata@kushiro-pu.ac.jp)
Toshiaki Watanabe: Professor, Institute of Economic Research, Hitotsubashi University (E-mail: watanabe@ier.hit-u.ac.jp) Institute for Monetary and Economic Studies, Bank of Japan

No 11-E-18, IMES Discussion Paper Series from Institute for Monetary and Economic Studies, Bank of Japan

Abstract: This article analyzes whether daily realized volatility, which is the sum of squared intraday returns over a day, is useful for option pricing. Different realized volatilities are calculated with or without taking account of microstructure noise and with or without using overnight and lunch-time returns. ARFIMA, ARFIMAX, HAR, HARX models are employed to specify the dynamics of realized volatility. ARFIMA and HAR models can capture the long-memory property and ARFIMAX and HARX models can also capture the asymmetry in volatility depending on the sign of previous day's return. Option prices are derived under the assumption of risk-neutrality. For comparison, GARCH, EGARCH and FIEGARCH models are estimated using daily returns, where option prices are derived by assuming the risk-neutrality and by using the Duan (1995) method in which the assumption of risk-neutrality is relaxed. Main results using the Nikkei 225 stock index and its put options prices are: (1) ARFIMAX model with daily realized volatility performs best, (2) the Hansen and Lunde ( 2005a) adjustment without using overnight and lunch-time returns can improve the performance, (3) if the Hansen and Lunde (2005a), which also plays a role to remove the bias caused by the microstructure noise by setting the sample mean of realized volatility equal to the sample variance of daily returns, is used, the other methods for taking account of microstructure noise do not necessarily improve the performance and (4) the Duan (1995) method does not improve the performance compared with assuming the risk neutrality.

Keywords: microstructure noise; Nikkei 225 stock index; non-trading hours; option pricing; realized volatility (search for similar items in EconPapers)
JEL-codes: C22 C52 G13 (search for similar items in EconPapers)
Date: 2011-08
New Economics Papers: this item is included in nep-fmk and nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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