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Option pricing under GARCH models with Hansen's skewed-t distributed innovations

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  • Liu, Yanxin
  • Li, Johnny Siu-Hang
  • Ng, Andrew Cheuk-Yin

Abstract

Recently, there has been a wave of work on option pricing under GARCH-type models with non-normal innovations. However, many of the existing valuation results rely on the existence of the moment generating function of the innovations’ distribution, thereby ruling out the use of heavy-tailed distributions such as Student's t and its variants, which may better capture the excess kurtosis in historical asset returns. In this paper, we consider option pricing under GARCH models with Hansen's skewed-t distributed innovations. To overcome the limitations of the existing valuation results, we apply risk-neutralization to the empirical distribution of the simulated sample paths rather than the innovations’ parametric distribution. We illustrate our proposed method by pricing options written on the S&P 500 index.

Suggested Citation

  • Liu, Yanxin & Li, Johnny Siu-Hang & Ng, Andrew Cheuk-Yin, 2015. "Option pricing under GARCH models with Hansen's skewed-t distributed innovations," The North American Journal of Economics and Finance, Elsevier, vol. 31(C), pages 108-125.
    • Handle: RePEc:eee:ecofin:v:31:y:2015:i:c:p:108-125
    DOI: 10.1016/j.najef.2014.10.007
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