Articles

What is beneath the surface? Option pricing with multifrequency latent states

L. CALVET, M. FEARNLEY, A. FISHER, M. LEIPPOLD

Journal of Econometrics

août 2015, vol. 187, n°2, pp.498-511

Départements : Finance

Mots clés : Markov-switching multifractal, Particle filter, Regime-switching, Stochastic volatility, Jump-risk premium, Option pricing

http://ssrn.com/abstract=2171734


We introduce a tractable class of multi-factor price processes with regime-switching stochastic volatility and jumps, which flexibly adapt to changing market conditions and permit fast option pricing. A small set of structural parameters, whose dimension is invariant to the number of factors, fully specifies the joint dynamics of the underlying asset and options implied volatility surface. We develop a novel particle filter for efficiently extracting the latent state from joint S&P 500 returns and options data. The model outperforms standard benchmarks in- and out-of-sample, and remains robust even in the wake of seemingly large discontinuities such as the recent financial crisis.


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