Specification Analysis of Option Pricing Models Based on Time-Changed Levy Processes

Jingzhi Huang and Liuren Wu

No 405, Econometric Society 2004 North American Winter Meetings from Econometric Society

Abstract: This article analyzes the specifications of option pricing models based on time-changed Levy processes. We classify option pricing models based on (i) the structure of the jump component in the underlying return process, (ii) the source of stochastic volatility, and (iii) the specification of the volatility process itself. We then consider a variety of model specifications within this framework, and investigate empirically what type of jump structure best describe the underlying price movement and whether stochastic volatility comes from jump or diffusion. We find that, to capture the behavior of the S&P 500 index options, one needs to incorporate an infinite activity jump component in the underlying asset return process, and also to include stochastic volatilities from two separate sources: both the jump and the diffusion components

Keywords: Option pricing; Levy processes; time change; jumps; diffusion; stochastic volatility (search for similar items in EconPapers)
JEL-codes: F31 G12 G13 (search for similar items in EconPapers)
Date: 2004-08-11
New Economics Papers: this item is included in nep-fin
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (114)

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Working Paper: Specification Analysis of Option Pricing Models Based on Time- Changed Levy Processes (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:ecm:nawm04:405

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