ON ESTIMATION OF VOLATILITY OF FINANCIAL TIME SERIES FOR PRICING DERIVATIVES

Michal Černý

Acta Oeconomica Pragensia, 2008, vol. 2008, issue 4, pages 12-21

Abstract: Estimation of volatility of financial time series plays a crucial role in pricing derivatives. Volatility is often estimated from historical data; however, it is well known that volatility varies in time. We propose a method to choose a suitable length of historical data to estimate contemporary volatility. The method is based on adaptation of a procedure used in statistical quality control - a hypothesis, that data contains a changepoint of volatility, is tested and if the test gives a positive answer, the changepoint is estimated. Then, a period of data where no changepoint is statistically significant is used to estimate contemporary volatility. The approach is illustrated on an analysis of CZK/EUR exchange rates.

Keywords: Derivative; Black-Scholes model; time series; volatility; changepoint (search for similar items in EconPapers)
JEL-codes: C12 C13 G12 (search for similar items in EconPapers)
Date: 2008

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