Which GARCH Model for Option Valuation?
Peter Christoffersen and
Kris Jacobs ()
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Kris Jacobs: Faculty of Management, McGill University, Montréal, Québec, Canada, and CIRANO
Management Science, 2004, vol. 50, issue 9, 1204-1221
Characterizing asset return dynamics using volatility models is an important part of empirical finance. The existing literature on GARCH models favors some rather complex volatility specifications whose relative performance is usually assessed through their likelihood based on a time series of asset returns. This paper compares a range of GARCH models along a different dimension, using option prices and returns under the risk-neutral as well as the physical probability measure. We judge the relative performance of various models by evaluating an objective function based on option prices. In contrast with returns-based inference, we find that our option-based objective function favors a relatively parsimonious model. Specifically, when evaluated out-of-sample, our analysis favors a model that, besides volatility clustering, only allows for a standard leverage effect.
Keywords: option pricing; GARCH; risk-neutral pricing; parsimony; forecasting; out-of-sample (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:50:y:2004:i:9:p:1204-1221
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