GARCH Options in Incomplete Markets

Giovanni, Barone-Adesi, Robert F. Engle and Mancini Loriano

No 2005-12, CEI Working Paper Series from Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University

Abstract: We propose a new method to compute option prices based on GARCH models. In an incomplete market framework, we allow for the volatility of asset return to differ from the volatility of the pricing process and obtain adequate pricing results. We investigate the pricing performance of this approach over short and long time horizons by calibrating theoretical option prices under the Asymmetric GARCH model on S&P 500 market option prices. A new simplified scheme for delta hedging is proposed.

Date: 2006-03
Note: First Version: March 2004; Revised: October 2004
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