We nest multiple volatility components, fat tails and a U-shaped pricing kernel in a single option model and compare their contribution to describing returns and option data. All three features lead to statistically significant model improvements. A U-shaped pricing kernel is economically most important and improves option fit by 17% on average and more so for two-factor models. A second volatility component improves the option fit by 9% on average. Fat tails improve option fit by just over 4% on average, but more so when a U-shaped pricing kernel is applied. Overall these three model features are complements rather than substitutes: the importance of one feature increases in conjunction with the others.
|Udgiver||Rotman School of Management, University of Toronto|
|Status||Udgivet - nov. 2016|
|Navn||Rotman School of Management Working Paper|
- Volatility components
- Fat tails
- Pricing kernel
Babaoglu, K., Christoffersen, P., Heston, S. L., & Jacobs, K. (2016). Option Valuation with Volatility Components, Fat Tails, and Non-Monotonic Pricing Kernels. Rotman School of Management, University of Toronto. Rotman School of Management Working Paper, Nr. 2690888 https://doi.org/10.2139/ssrn.2690888