GARCH Option Pricing Under Skew
Sofiane Aboura ()
Finance from University Library of Munich, Germany
This article is an empirical study dedicated to the GARCH Option pricing model of Duan (1995) applied to the FTSE 100 European style options for various maturities. The beauty of this model is to have used the standard GARCH theory in an option perspective and also it is its flexibility to adapt to different rich GARCH specifications. We analyze the valididy of the model given its ability to price one-day ahead out- of-sample call options and also its ability to capture the empirical dynamic of the volatility skew. We get severe mispricing for deep out- of-the-money and short term call options, which tend to decrease the global performance of the model that is relatively correct. We note that long term skews tend to be more stable across time and strikes, which explains why we had a decreasing pricing bias for longer maturity contracts. We also get that skews tend to deform into smiles as we go toward the expiry date. This model reveals a good ability to capture the change of regime in the implied volatility surface judging from the transformation observed from smiles to skews.
Keywords: GARCH Option models; Monte Carlo simulations; Implied Volatility; Volatility Smile. (search for similar items in EconPapers)
JEL-codes: C13 G13 (search for similar items in EconPapers)
Pages: 14 pages
New Economics Papers: this item is included in nep-ets and nep-fin
Note: Type of Document - pdf; pages: 14
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpfi:0405032
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