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

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

Research output: Contribution to conferencePaperResearchpeer-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 languageEnglish
Publication date18 Feb 2014
Number of pages44
Publication statusPublished - 18 Feb 2014
EventThe 41th European Finance Association Annual Meeting (EFA 2014) - Palazzo dei Congressi, Lugano, Switzerland
Duration: 27 Aug 201430 Aug 2014
Conference number: 41
http://www.efa2014.org/

Conference

ConferenceThe 41th European Finance Association Annual Meeting (EFA 2014)
Number41
LocationPalazzo dei Congressi
CountrySwitzerland
CityLugano
Period27/08/201430/08/2014
Internet address

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