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A Stochastic Volatility Model With Realized Measures for Option Pricing

Bormetti, G., Casarin, R., Corsi, F. ORCID: 0000-0003-2683-4479 & Livieri, G. (2019). A Stochastic Volatility Model With Realized Measures for Option Pricing. Journal of Business & Economic Statistics, doi: 10.1080/07350015.2019.1604371


Based on the fact that realized measures of volatility are affected by measurement errors, we introduce a new family of discrete-time stochastic volatility models having two measurement equations relating both observed returns and realized measures to the latent conditional variance. A semi-analytical option pricing framework is developed for this class of models. In addition, we provide analytical filtering and smoothing recursions for the basic specification of the model, and an effective MCMC algorithm for its richer variants. The empirical analysis shows the effectiveness of filtering and smoothing realized measures in inflating the latent volatility persistence—the crucial parameter in pricing Standard and Poor’s 500 Index options.

Publication Type: Article
Additional Information: This is an Accepted Manuscript of an article published by Taylor & Francis in Journal of Business & Economic Statistics on 31 May 2019, available online:
Publisher Keywords: Bayesian inference, High-frequency data, Monte Carlo Markov chain, Option pricing, Realized volatility
Subjects: H Social Sciences > HA Statistics
H Social Sciences > HB Economic Theory
Departments: School of Policy & Global Affairs > Economics
Text - Accepted Version
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