City Research Online

Abstract

We develop a discrete-time stochastic volatility option pricing model exploiting the information contained in the Realized Volatility (RV), which is used as a proxy of the unobservable log-return volatility. We model the RV dynamics by a simple and effective long-memory process, whose parameters can be easily estimated using historical data. Assuming an exponentially affine stochastic discount factor, we obtain a fully analytic change of measure. An empirical analysis of Standard and Poor's 500 index options illustrates that our model outperforms competing time-varying and stochastic volatility option pricing models.

Publication Type:	Article
Additional Information:	NOTICE: this is the author’s version of a work that was accepted for publication in Journal of Financial Economics. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in Journal of Financial Economics, Volume 107, Issue 2, February 2013, Pages 284–304, http://dx.doi.org/10.1016/j.jfineco.2012.08.015
Publisher Keywords:	High-frequency, Realized volatility, Option pricing
Subjects:	H Social Sciences > HB Economic Theory
Departments:	School of Policy & Global Affairs > Economics
Related URLs:	Author
SWORD Depositor:	Symplectic Administrator

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