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Specification Analysis of Option Pricing Models Based on Time- Changed Levy Processes

Author

Listed:
  • Jingzhi Huang

    (Penn State)

  • Liuren Wu

    (Baruch College)

Abstract

We analyze the specifications of option pricing models based on time- changed Levy processes. We classify option pricing models based on the structure of the jump component in the underlying return process, the source of stochastic volatility, and the specification of the volatility process itself. Our estimation of a variety of model specifications indicates that to better capture the behavior of the S&P 500 index options, we need to incorporate a high frequency jump component in the return process and generate stochastic volatilities from two different sources, the jump component and the diffusion component.

Suggested Citation

  • Jingzhi Huang & Liuren Wu, 2004. "Specification Analysis of Option Pricing Models Based on Time- Changed Levy Processes," Finance 0401002, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0401002
    Note: Type of Document - pdf; prepared on WinXP; pages: 48; figures: 3
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    References listed on IDEAS

    as
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    Keywords

    Option pricing; Levy processes; time change; jumps; Diffusion; stochastic volatility; finite activity; infinite activity; infinite variation.;
    All these keywords.

    JEL classification:

    • G - Financial Economics

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