Pricing and hedging index options under stochastic volatility: an empirical examination

Arbeitspapier

An empirical examination of the pricing and hedging performance of a stochastic volatility (SV) model with closed form solution (Heston 1993) is provided for options on the S&P 500 index in which the unobservable time varying volatility is jointly estimated with the time invariant parameters of the model. Although, out-of-sample, the mean absolute pricing error in the SV model is always lower than in the Black-Scholes model, still substantial mispricings are observed for deep out-of-the-money options. The degree of mispricing in different options classes is related to bid-ask spreads on options and options trading volume after controlling for moneyness and maturity biases. Taking into account the transactions costs (bid-ask spreads) in the options market and using S&P 500 futures to hedge, it is found that the stochastic volatility model yields lower variance for a minimum variance hedge portfolio than the Black-Scholes model for most classes of options and the differences in variances are statistically significant.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Working Paper ; No. 96-9

Classification and Topics

• Classification: Wirtschaft
• Subject: Hedging (Finance) ; Options (Finance)

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Nandi, Saikat
• Event: Veröffentlichung
• (who): Federal Reserve Bank of Atlanta
• (where): Atlanta, GA
• (when): 1996

Further information

• Handle: http://hdl.handle.net/10419/100900
• Last update: 10.03.2025, 11:43 AM CET