Year: 2009
Author: Lehnert, Thorsten
Credit and Capital Markets – Kredit und Kapital, Vol. 42 (2009), Iss. 1 : pp. 125–144
Abstract
Mandelbrot and the Smile
It is a well-documented empirical fact that index option prices systematically differ from Black-Scholes prices. However, previous research provides inconclusive results whether the observed volatility smile could be explained by a discretetime dynamic model of stock returns with skewed, leptokurtic innovations. The improvements in pricing errors are particularly pronounced for out-of-the money put options, while the models partly underperform a Gaussian alternative for near-the-money options. Motivated by theses empirical evidence, I develop a new GARCH option-pricing model with a more flexible innovation structure. In an application of the model to DAX index options, I test the relative performance of the approach against a standard nested GARCH specification and the well-known practitioners Black-Scholes model. I show that the performance of the truncated Lévy GARCH option pricing model is superior to existing approaches. (JEL G12)
Journal Article Details
Publisher Name: Global Science Press
Language: English
DOI: https://doi.org/10.3790/kuk.42.1.125
Credit and Capital Markets – Kredit und Kapital, Vol. 42 (2009), Iss. 1 : pp. 125–144
Published online: 2009-04
AMS Subject Headings: Duncker & Humblot
Copyright: COPYRIGHT: © Global Science Press
Pages: 20