Option Implied Tail Index and Volatility Based on Heavy-tailed Distributions: Evidence from KOSPI 200 Index Options Market

Joocheol Kim and Hyun-Oh Kim

Global Economic Review, 2014, vol. 43, issue 3, 269-284

Abstract: This paper compares the option implied tail indexes and volatilities from two option pricing formulas based on heavy-tailed distributions: generalized extreme value (GEV) distribution and generalized logistic (GLO) distribution. Option pricing models based on heavy-tailed distributions with three parameters overcome some well-known drawbacks of the Black-Scholes model when the realized underlying asset returns are not normally distributed. Both GEV-based and GLO-based option pricing formulas extract the implied volatilities successfully, indicating that they are compatible with the Black-Scholes formulas. However, GEV-based pricing model shows more unexpected patterns when extracting the implied tail indexes for put options than GLO-based pricing model including the credit crisis in 2008, implying that GEV-based pricing model is less capable of measuring the market sentiment during the extreme crisis events.

Date: 2014
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DOI: 10.1080/1226508X.2014.941377

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