Option Valuation with IG-GARCH Model and an U-Shaped Pricing Kernel

Christophe Chorro () and Fanirisoa Rahantamialisoa H. ()
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Christophe Chorro: Centre d'Economie de la Sorbonne, https://centredeconomiesorbonne.univ-paris1.fr
Fanirisoa Rahantamialisoa H.: Centre d'Economie de la Sorbonne, https://centredeconomiesorbonne.univ-paris1.fr

Documents de travail du Centre d'Economie de la Sorbonne from Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne

Abstract: Empirical and theoretical studies have attempted to establish the U-shape of the log-ratio of conditional risk-neutral and physical probability density functions. The main subject of this paper is to question the use of such a U-shaped pricing kernel to improve option pricing performances. Starting from the so-called Inverse Gaussian GARCH model (IG-GARCH), known to provide semi-closed form formulas for classical European derivatives when an exponential affine pricing kernel is used, we build a new pricing kernel that is non-monotonic and that still has this remarkable property. Using a daily dataset of call options written on the S&P500 index, we compare the pricing performances of these two IG-GARCH models proving, in this framework, that the new exponential U-shaped stochastic discount factor clearly outperforms the classical exponential affine one. What is more, several estimation strategies including options or VIX information are tested taking advantage of the analytical tractability of these models

Keywords: Option valuation; Pricing kernel; VIX; IG-GARCH; S&P500 (search for similar items in EconPapers)
JEL-codes: G12 G22 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2016-11
New Economics Papers: this item is included in nep-cfn
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Persistent link: https://EconPapers.repec.org/RePEc:mse:cesdoc:16074

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