Stochastic Volatility and Pricing Bias in the Swedish OMX-Index Call Option Market

Hans Byström

No 2000:16, Working Papers from Lund University, Department of Economics

Abstract: This paper investigates the pricing bias in the Swedish OMX-Index Option market and how a stochastic volatility affects European call option prices. The market is purely European and without dividends for the period studied. A CIR square-root process for the volatility is estimated with non-linear least square minimization, and stochastic volatility option prices are calculated through Fourier-Inversion. These call option prices are compared to Black-Scholes prices as well as observed market prices, and a well-defined bias structure between Stochastic Volatility prices and Black-Scholes prices is observed. With a dynamic hedging scheme, I demonstrate larger (ex ante) profits, excluding transaction costs, for traders using the stochastic volatility model rather than the Black-Scholes model

Keywords: derivatives pricing; stochastic volatility; Fourier inversion (search for similar items in EconPapers)
JEL-codes: C52 G13 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2000-11-06
New Economics Papers: this item is included in nep-fmk
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:lunewp:2000_016

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