Option pricing with non-Gaussian scaling and infinite-state switching volatility

Fulvio Baldovin, Massimiliano Caporin, Michele Caraglio, Attilio L. Stella and Marco Zamparo

Journal of Econometrics, 2015, vol. 187, issue 2, 486-497

Abstract: Volatility clustering, long-range dependence, and non-Gaussian scaling are stylized facts of financial assets dynamics. They are ignored in the Black & Scholes framework, but have a relevant impact on the pricing of options written on financial assets. Using a recent model for market dynamics which adequately captures the above stylized facts, we derive closed form equations for option pricing, obtaining the Black & Scholes as a special case. By applying our pricing equations to a major equity index option dataset, we show that inclusion of stylized features in financial modelling moves derivative prices about 30% closer to the market values without the need of calibrating models parameters on available derivative prices.

Keywords: Option pricing; Anomalous scaling; Markov switching; GARCH (search for similar items in EconPapers)
JEL-codes: C22 C51 C52 C53 C58 G13 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Working Paper: Option pricing with non-Gaussian scaling and infinite-state switching volatility (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:187:y:2015:i:2:p:486-497

DOI: 10.1016/j.jeconom.2015.02.033

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