Index Option Pricing via Nonparametric Regression
Investors typically use the Black-Scholes (B-S) parametric model to value financial options. However, there is extensive empirical evidence that the B-S model, assuming constant volatility of stock returns, is far from adequate to price options. This paper, using nonparametric regression, incorpora...
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| Format: | Article |
| Language: | English |
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SGH Warsaw School of Economics, Collegium of Economic Analysis
2022-12-01
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| Series: | Econometric Research in Finance |
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| Online Access: | https://www.erfin.org/journal/index.php/erfin/article/view/168 |
| _version_ | 1811196551073103872 |
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| author | Ka Po Kung |
| author_facet | Ka Po Kung |
| author_sort | Ka Po Kung |
| collection | DOAJ |
| description |
Investors typically use the Black-Scholes (B-S) parametric model to value financial options. However, there is extensive empirical evidence that the B-S model, assuming constant volatility of stock returns, is far from adequate to price options. This paper, using nonparametric regression, incorporates a volatility-adjusting mechanism into the B-S model and prices options on the S&P 500 Index. Specifically, the upgraded B-S model, referred to as the B-S nonparametric model, is equipped with such a mechanism whose function is to assign larger volatilities for larger log returns and smaller volatilities for smaller log returns to characterize volatility clustering, a phenomenon such that large/small log returns tend to be followed by large/small log returns. Using the B-S nonparametric models as a yardstick, our simulation results show that, across the board, the B-S parametric model considerably overprices both call and put options.
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| first_indexed | 2024-04-12T00:59:41Z |
| format | Article |
| id | doaj.art-0b5119ac64b04627b5a23d069bc3299a |
| institution | Directory Open Access Journal |
| issn | 2451-1935 2451-2370 |
| language | English |
| last_indexed | 2024-04-12T00:59:41Z |
| publishDate | 2022-12-01 |
| publisher | SGH Warsaw School of Economics, Collegium of Economic Analysis |
| record_format | Article |
| series | Econometric Research in Finance |
| spelling | doaj.art-0b5119ac64b04627b5a23d069bc3299a2022-12-22T03:54:29ZengSGH Warsaw School of Economics, Collegium of Economic AnalysisEconometric Research in Finance2451-19352451-23702022-12-017110.2478/erfin-2022-0004Index Option Pricing via Nonparametric RegressionKa Po Kung0National University of Singapore, Singapore Investors typically use the Black-Scholes (B-S) parametric model to value financial options. However, there is extensive empirical evidence that the B-S model, assuming constant volatility of stock returns, is far from adequate to price options. This paper, using nonparametric regression, incorporates a volatility-adjusting mechanism into the B-S model and prices options on the S&P 500 Index. Specifically, the upgraded B-S model, referred to as the B-S nonparametric model, is equipped with such a mechanism whose function is to assign larger volatilities for larger log returns and smaller volatilities for smaller log returns to characterize volatility clustering, a phenomenon such that large/small log returns tend to be followed by large/small log returns. Using the B-S nonparametric models as a yardstick, our simulation results show that, across the board, the B-S parametric model considerably overprices both call and put options. https://www.erfin.org/journal/index.php/erfin/article/view/168Black-Scholes Parametric ModelBlack-Scholes Nonparametric ModelsIndex OptionsVolatilityKernels |
| spellingShingle | Ka Po Kung Index Option Pricing via Nonparametric Regression Econometric Research in Finance Black-Scholes Parametric Model Black-Scholes Nonparametric Models Index Options Volatility Kernels |
| title | Index Option Pricing via Nonparametric Regression |
| title_full | Index Option Pricing via Nonparametric Regression |
| title_fullStr | Index Option Pricing via Nonparametric Regression |
| title_full_unstemmed | Index Option Pricing via Nonparametric Regression |
| title_short | Index Option Pricing via Nonparametric Regression |
| title_sort | index option pricing via nonparametric regression |
| topic | Black-Scholes Parametric Model Black-Scholes Nonparametric Models Index Options Volatility Kernels |
| url | https://www.erfin.org/journal/index.php/erfin/article/view/168 |
| work_keys_str_mv | AT kapokung indexoptionpricingvianonparametricregression |