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Herding and Stochastic Volatility


Farkas, W; Necula, Ciprian; Waelchli, Boris (2015). Herding and Stochastic Volatility. SSRN 2685939, University of Zurich.

Abstract

In this paper we develop a one-factor non-affine stochastic volatility option pricing model where the dynamics of the underlying is endogenously determined from micro-foundations. The interaction and herding of the agents trading the underlying asset induce an amplification of the volatility of the asset over the volatility of the fundamentals. Although the model is non-affine, a closed form option pricing formula can still be derived by using a Gauss-Hermite series expansion methodology. The model is calibrated using S&P 500 index options for the period 1996-2013. When its results are compared to some benchmark models we find that the new non-affine one-factor model outperforms the affine one-factor Heston model and it is competitive, especially out-of-sample, with the affine two-factor double Heston model.

In this paper we develop a one-factor non-affine stochastic volatility option pricing model where the dynamics of the underlying is endogenously determined from micro-foundations. The interaction and herding of the agents trading the underlying asset induce an amplification of the volatility of the asset over the volatility of the fundamentals. Although the model is non-affine, a closed form option pricing formula can still be derived by using a Gauss-Hermite series expansion methodology. The model is calibrated using S&P 500 index options for the period 1996-2013. When its results are compared to some benchmark models we find that the new non-affine one-factor model outperforms the affine one-factor Heston model and it is competitive, especially out-of-sample, with the affine two-factor double Heston model.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:2015
Deposited On:26 Nov 2015 11:03
Last Modified:05 Apr 2016 19:33
Series Name:SSRN
Free access at:Official URL. An embargo period may apply.
Official URL:http://ssrn.com/abstract=2685939
Other Identification Number:merlin-id:12581, 2685939
Permanent URL: https://doi.org/10.5167/uzh-115034

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