Option Valuation with Volatility Components, Fat Tails, and Nonlinear Pricing Kernels

Kadir Gokhan Babaoglu; Peter  Christoffersen; Steven Heston; Kris Jacobs

Option Valuation with Volatility Components, Fat Tails, and Nonlinear Pricing Kernels

Kadir Gokhan Babaoglu, Peter Christoffersen, Steven Heston, Kris Jacobs

Department of Finance

Research output: Contribution to conference › Paper › Research › peer-review

Abstract

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 second volatility factor is economically most important and improves option …fit by 18% on average. A U-shaped pricing kernel improves the option fit by 17% on average, and more so for two-factor models. Fat tails improve option …fit by just over 3% on average, and more so when a U-shaped pricing kernel is applied. Our results suggest that the three features we investigate are complements rather than substitutes.

Original language	English
Publication date	18 Feb 2014
Number of pages	44
Publication status	Published - 18 Feb 2014
Event	The 41th European Finance Association Annual Meeting (EFA 2014) - Palazzo dei Congressi, Lugano, Switzerland Duration: 27 Aug 2014 → 30 Aug 2014 Conference number: 41 http://www.efa2014.org/

Conference

Conference	The 41th European Finance Association Annual Meeting (EFA 2014)
Number	41
Location	Palazzo dei Congressi
Country/Territory	Switzerland
City	Lugano
Period	27/08/2014 → 30/08/2014
Internet address	http://www.efa2014.org/

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Babaoglu, K. G., Christoffersen, P., Heston, S., & Jacobs, K. (2014). Option Valuation with Volatility Components, Fat Tails, and Nonlinear Pricing Kernels. Paper presented at The 41th European Finance Association Annual Meeting (EFA 2014), Lugano, Switzerland. https://www.conftool.com/efa2014/index.php/EFA_2014-336-Babaoglu-Option_Valuation_with_Volatility_Components%2C_Fat_Tails%2C_and_Nonlinear_Pricing_Kernels_a.pdf?page=downloadPaper&filename=EFA_2014-336-Babaoglu-Option_Valuation_with_Volatility_Components%2C_Fat_Tails%2C_and_Nonlinear_Pricing_Kernels_a.pdf&form_id=336

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title = "Option Valuation with Volatility Components, Fat Tails, and Nonlinear Pricing Kernels",

abstract = "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 second volatility factor is economically most important and improves option …fit by 18% on average. A U-shaped pricing kernel improves the option fit by 17% on average, and more so for two-factor models. Fat tails improve option …fit by just over 3% on average, and more so when a U-shaped pricing kernel is applied. Our results suggest that the three features we investigate are complements rather than substitutes.",

keywords = "Volatility components, Fat tails, Jumps, Pricing kernel",

author = "Babaoglu, {Kadir Gokhan} and Peter Christoffersen and Steven Heston and Kris Jacobs",

year = "2014",

month = feb,

day = "18",

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note = "The 41th European Finance Association Annual Meeting (EFA 2014) ; Conference date: 27-08-2014 Through 30-08-2014",

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Babaoglu, KG, Christoffersen, P, Heston, S & Jacobs, K 2014, 'Option Valuation with Volatility Components, Fat Tails, and Nonlinear Pricing Kernels', Paper presented at The 41th European Finance Association Annual Meeting (EFA 2014), Lugano, Switzerland, 27/08/2014 - 30/08/2014. <https://www.conftool.com/efa2014/index.php/EFA_2014-336-Babaoglu-Option_Valuation_with_Volatility_Components%2C_Fat_Tails%2C_and_Nonlinear_Pricing_Kernels_a.pdf?page=downloadPaper&filename=EFA_2014-336-Babaoglu-Option_Valuation_with_Volatility_Components%2C_Fat_Tails%2C_and_Nonlinear_Pricing_Kernels_a.pdf&form_id=336>

TY - CONF

T1 - Option Valuation with Volatility Components, Fat Tails, and Nonlinear Pricing Kernels

AU - Babaoglu, Kadir Gokhan

AU - Christoffersen, Peter

AU - Heston, Steven

AU - Jacobs, Kris

N1 - Conference code: 41

PY - 2014/2/18

Y1 - 2014/2/18

N2 - 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 second volatility factor is economically most important and improves option …fit by 18% on average. A U-shaped pricing kernel improves the option fit by 17% on average, and more so for two-factor models. Fat tails improve option …fit by just over 3% on average, and more so when a U-shaped pricing kernel is applied. Our results suggest that the three features we investigate are complements rather than substitutes.

AB - 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 second volatility factor is economically most important and improves option …fit by 18% on average. A U-shaped pricing kernel improves the option fit by 17% on average, and more so for two-factor models. Fat tails improve option …fit by just over 3% on average, and more so when a U-shaped pricing kernel is applied. Our results suggest that the three features we investigate are complements rather than substitutes.

KW - Volatility components

KW - Fat tails

KW - Jumps

KW - Pricing kernel

M3 - Paper

T2 - The 41th European Finance Association Annual Meeting (EFA 2014)

Y2 - 27 August 2014 through 30 August 2014

ER -