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Stochastic Volatility and the Informational Content of Option Prices: Empirical Analysis

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  • Antonio Mele

    (THEMA)

  • Fabio Fornari

    (Bank of Italy)

Abstract

We compare the state-price density that is implied by the cross-section of options prices with the corresponding density of the underlying asset price that is derived from an equilibrium model with Markovian stochastic volatility. If the data-generating process is of the stochastic volatility type and if options are correctly priced, the two densities should be identical. Such work has been motivated by the negative results obtained by Aðt-Sahalia, Wang and Yard (1998) in the case of a simple, complete-markets setting in which the volatility of the underlying asset price only depended on the underlying asset price.

Suggested Citation

  • Antonio Mele & Fabio Fornari, 1999. "Stochastic Volatility and the Informational Content of Option Prices: Empirical Analysis," Computing in Economics and Finance 1999 912, Society for Computational Economics.
    • Handle: RePEc:sce:scecf9:912
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    References listed on IDEAS

    as
    1. John C. Cox & Jonathan E. Ingersoll Jr. & Stephen A. Ross, 2005. "A Theory Of The Term Structure Of Interest Rates," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 5, pages 129-164, World Scientific Publishing Co. Pte. Ltd..
    2. F. Fornari & A. Mele, 1998. "ARCH Models and Option Pricing : The Continuous Time Connection," THEMA Working Papers 98-30, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
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    5. Broze, Laurence & Scaillet, Olivier & Zakoïan, Jean-Michel, 1998. "Quasi-Indirect Inference For Diffusion Processes," Econometric Theory, Cambridge University Press, vol. 14(2), pages 161-186, April.
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    7. Ait-Sahalia, Yacine, 1996. "Testing Continuous-Time Models of the Spot Interest Rate," The Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 385-426.
    8. Fabio Fornari & Antonio Mele, 1997. "Weak convergence and distributional assumptions for a general class of nonliner arch models," Econometric Reviews, Taylor & Francis Journals, vol. 16(2), pages 205-227.
    9. Wiggins, James B., 1987. "Option values under stochastic volatility: Theory and empirical estimates," Journal of Financial Economics, Elsevier, vol. 19(2), pages 351-372, December.
    10. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-384, March.
    11. Longstaff, Francis A & Schwartz, Eduardo S, 1992. "Interest Rate Volatility and the Term Structure: A Two-Factor General Equilibrium Model," Journal of Finance, American Finance Association, vol. 47(4), pages 1259-1282, September.
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