Testing option pricing models: complete and incomplete markets

Olesia Verchenko ()
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Olesia Verchenko: Kyiv School of Economics, Kyiv Economic Institute

No 38, Discussion Papers from Kyiv School of Economics

Abstract: This paper examines the empirical performance of several complete and incomplete market models of stock price dynamics using S&P 500 options and stock market data. The main contribution of this work is that it suggests and implements an empirical approach to estimating a complete model with uncertain volatility, and then judges it against other popular option pricing processes. The performance of alternative models is evaluated from four perspectives: (1) in-sample fit to stock returns data, (2) in-sample fit to options data, (3) consistency of physical and risk-neutral parameter estimates and (4) out-of-sample option pricing. Overall, the complete model with uncertain volatility is found to .t the data much better than models with constant and price-level-dependent volatilities, and the variance gamma process, and its performance is comparable to that of a stochastic volatility model.

Keywords: Option pricing; complete and incomplete markets; stochastic volatility (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2011-04
New Economics Papers: this item is included in nep-fmk, nep-mst, nep-ore and nep-rmg
Note: Submitted to Journal of Derivatives
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http://repec.kse.org.ua/pdf/KSE_dp38.pdf May 2011 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:kse:dpaper:38

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