Option Valuation with Long-run and Short-run Volatility Components

Peter Christoffersen, Kris Jacobs and Yintian Wang

CIRANO Working Papers from CIRANO

Abstract: This paper presents a new model for the valuation of European options. In our model, the volatility of returns consists of two components. One of these components is a long-run component, and it can be modeled as fully persistent. The other component is short-run and has a zero mean. Our model can be viewed as an affine version of Engle and Lee (1999), allowing for easy valuation of European options. We investigate the model through an integrated analysis of returns and options data. The performance of the model is spectacular when compared to a benchmark single-component volatility model that is well-established in the literature. The improvement in the model's performance is due to its richer dynamics which enable it to jointly model long-maturity and short-maturity options Ce papier présente un nouveau modèle d'évaluation d'options européennes. Dans notre modèle, la volatilité des rendements se décompose en deux parties. Une des composantes est une composante de long terme, et elle peut être modélisée comme permanente. L'autre composante porte sur le court terme et est de moyenne nulle. Notre modèle peut être considéré comme la version affine de Engle & Lee (1999), permettant l'évaluation simple d'options européennes. Nous étudions le modèle à travers une analyse intégrée de données de rendements et d'options. La performance du modèle est spectaculaire comparée à un benchmark tel qu'un modèle à une seule composante de volatilité bien connu dans la littérature. L'amélioration de la performance du modèle est due à une dynamique plus riche qui permet de modéliser conjointement des options à maturité longue et à maturité courte

Keywords: option valuation; long-run component; short-run component; unobserved components; persistence; GARCH; out-of-sample; évaluation d'option; composante long terme; composante court terme; composantes non observables; persistance; GARCH; hors échantillon (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2004-11-01
New Economics Papers: this item is included in nep-ets and nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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https://cirano.qc.ca/files/publications/2004s-56.pdf

Related works:
Journal Article: Option valuation with long-run and short-run volatility components (2008)
Working Paper: Option Valuation with Long-run and Short-run Volatility Components (2008)
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Persistent link: https://EconPapers.repec.org/RePEc:cir:cirwor:2004s-56

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