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arXiv · 1307.6322

Option pricing with non-Gaussian scaling and infinite-state switching volatility

Fulvio Baldovin·Massimiliano Caporin·Michele Caraglio·Attilio Stella·Marco Zamparo
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Abstract

Volatility clustering, long-range dependence, and non-Gaussian scaling are stylized facts of financial assets dynamics. They are ignored in the Black & Scholes framework, but have a relevant impact on the pricing of options written on financial assets. Using a recent model for market dynamics which adequately captures the above stylized facts, we derive closed form equations for option pricing, obtaining the Black & Scholes as a special case. By applying our pricing equations to a major equity index option dataset, we show that inclusion of stylized features in financial modeling moves derivative prices about 30% closer to the market values without the need of calibrating models parameters on available derivative prices.

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Fulvio Baldovin, Massimiliano Caporin, Michele Caraglio, Attilio Stella, Marco Zamparo. 2013-07-24. Option pricing with non-Gaussian scaling and infinite-state switching volatility. https://doi.org/10.1016/j.jeconom.2015.02.033

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