STOCHASTIC VOLATILITY AND JUMP-DIFFUSION — IMPLICATIONS ON OPTION PRICING

George J. Jiang ()
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George J. Jiang: Schulich School of Business, York University, Canada and Faculty of Business and Economics, University of Groningen, The Netherlands

International Journal of Theoretical and Applied Finance (IJTAF), 1999, vol. 02, issue 04, 409-440

Abstract: This paper conducts a thorough and detailed investigation on the implications of stochastic volatility and random jump on option prices. Both stochastic volatility and jump-diffusion processes admit asymmetric and fat-tailed distribution of asset returns and thus have similar impact on option prices compared to the Black–Scholes model. While the dynamic properties of stochastic volatility model are shown to have more impact on long-term options, the random jump is shown to have relatively larger impact on short-term near-the-money options. The misspecification risk of stochastic volatility as jump is minimal in terms of option pricing errors only when both the level of kurtosis of the underlying asset return distribution and the level of volatility persistence are low. While both asymmetric volatility and asymmetric jump can induce distortion of option pricing errors, the skewness of jump offers better explanations to empirical findings on implied volatility curves.

Keywords: Stochastic volatility; jump-diffusion; option pricing; JEL classification code G13; JEL classification code C22; JEL classification code C52 (search for similar items in EconPapers)
Date: 1999
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Citations: View citations in EconPapers (2)

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DOI: 10.1142/S0219024999000212

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