Option Valuation with Observable Volatility and Jump Dynamics

Peter Christoffersen, Bruno Feunou and Yoontae Jeon ()
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Yoontae Jeon: University of Toronto, Rotman School of Management, Postal: 105 St.George Street, Toronto, ON M5S 3E6, Canada

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: Under very general conditions, the total quadratic variation of a jump-diffusion process can be decomposed into diffusive volatility and squared jump variation. We use this result to develop a new option valuation model in which the underlying asset price exhibits volatility and jump intensity dynamics. The volatility and jump intensity dynamics in the model are directly driven by model-free empirical measures of diffusive volatility and jump variation. Because the empirical measures are observed in discrete intervals, our option valuation model is cast in discrete time, allowing for straightforward filtering and estimation of the model. Our model belongs to the affine class enabling us to derive the conditional characteristic function so that option values can be computed rapidly without simulation. When estimated on S&P500 index options and returns the new model performs well compared with standard benchmarks.

Keywords: Dynamic volatility; dynamic jumps; realized volatility; realized jumps (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 47
Date: 2014-08-30
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https://repec.econ.au.dk/repec/creates/rp/15/rp15_07.pdf (application/pdf)

Related works:
Journal Article: Option valuation with observable volatility and jump dynamics (2015)
Working Paper: Option Valuation with Observable Volatility and Jump Dynamics (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:aah:create:2015-07

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