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Realizing smiles: Options pricing with realized volatility

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  • Corsi, Fulvio
  • Fusari, Nicola
  • La Vecchia, Davide

Abstract

We develop a discrete-time stochastic volatility option pricing model exploiting the information contained in the Realized Volatility (RV), which is used as a proxy of the unobservable log-return volatility. We model the RV dynamics by a simple and effective long-memory process, whose parameters can be easily estimated using historical data. Assuming an exponentially affine stochastic discount factor, we obtain a fully analytic change of measure. An empirical analysis of Standard and Poor's 500 index options illustrates that our model outperforms competing time-varying and stochastic volatility option pricing models.

Suggested Citation

  • Corsi, Fulvio & Fusari, Nicola & La Vecchia, Davide, 2013. "Realizing smiles: Options pricing with realized volatility," Journal of Financial Economics, Elsevier, vol. 107(2), pages 284-304.
    • Handle: RePEc:eee:jfinec:v:107:y:2013:i:2:p:284-304
    DOI: 10.1016/j.jfineco.2012.08.015
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    More about this item

    Keywords

    High-frequency; Realized volatility; Option pricing;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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