Permanent URL to this publication: http://dx.doi.org/10.5167/uzh-10865
Barone-Adesi, Giovanni; Engle, Robert F; Mancini, Loriano (2008). A GARCH option pricing model with filtered historical simulation. Review of Financial Studies, 21(3):1223-1258.
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We propose a new method for pricing options based on GARCH models with filtered historical innovations. In an incomplete market framework, we allow for different distributions of historical and pricing return dynamics, which enhances the model's flexibility to fit market option prices. An extensive empirical analysis based on S&P 500 index options shows that our model outperforms other competing GARCH pricing models and ad hoc Black-Scholes models. We show that the flexible change of measure, the asymmetric GARCH volatility, and the nonparametric innovation distribution induce the accurate pricing performance of our model. Using a nonparametric approach, we obtain decreasing state-price densities per unit probability as suggested by economic theory and corroborating our GARCH pricing model. Implied volatility smiles appear to be explained by asymmetric volatility and negative skewness of filtered historical innovations.
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|Item Type:||Journal Article, refereed, further contribution|
|Communities & Collections:||03 Faculty of Economics > Department of Banking and Finance|
|Dewey Decimal Classification:||330 Economics|
|Deposited On:||23 Jan 2009 10:44|
|Last Modified:||05 Apr 2016 12:51|
|Publisher:||Oxford University Press|
|Additional Information:||This is a pre-copy-editing, author-produced PDF of an article accepted for publication in The Review of Financial Studies following peer review. The definitive publisher-authenticated version Review of Financial Studies 21(3):1223-1258 is available online at: dx.doi.org/10.1093/rfs/hhn031.|
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