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Exploring Option Pricing and Hedging via Volatility Asymmetry

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  • Isabel Casas

    (University of Deusto
    University of Southern Denmark)

  • Helena Veiga

    (University Carlos III
    Universitário de Lisboa)

Abstract

This paper evaluates the application of two well-known asymmetric stochastic volatility (ASV) models to option price forecasting and dynamic delta hedging. They are specified in discrete time in contrast to the classical stochastic volatility models used in option pricing. There is some related literature, but little is known about the empirical implications of volatility asymmetry on option pricing. The objectives of this paper are to estimate ASV option pricing models using a Bayesian approach unknown in this type of literature, and to investigate the effect of volatility asymmetry on option pricing for different size equity sectors and periods of volatility. Using the S&P MidCap 400 and S&P 500 European call option quotes, results show that volatility asymmetry benefits the accuracy of option price forecasting and hedging cost effectiveness in the large-cap equity sector. However, ASV models do not improve the option price forecasting and dynamic hedging in the mid-cap equity sector.

Suggested Citation

  • Isabel Casas & Helena Veiga, 2021. "Exploring Option Pricing and Hedging via Volatility Asymmetry," Computational Economics, Springer;Society for Computational Economics, vol. 57(4), pages 1015-1039, April.
    • Handle: RePEc:kap:compec:v:57:y:2021:i:4:d:10.1007_s10614-020-10005-5
    DOI: 10.1007/s10614-020-10005-5
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    More about this item

    Keywords

    Delta hedging; Option; Stochastic volatility; Volatility asymmetry;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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