Chen Tong, Peter Reinhard Hansen, Zhuo Huang
arXiv 10 Dec 2021 · q-fin.PR · publishedJournal of Futures Markets (2022) · 5 citations (OpenAlex)
arXiv:2112.05308 · PDF · DOI · OpenAlex · Extracted main text
We introduce a new volatility model for option pricing that combines Markov switching with the Realized GARCH framework. This leads to a novel pricing kernel with a state-dependent variance risk premium and a pricing formula for European options, which is derived with an analytical approximation method. We apply the Markov switching Realized GARCH model to S&P 500 index options from 1990 to 2019 and find that investors' aversion to volatility-specific risk is time-varying. The proposed framework outperforms competing models and reduces (in-sample and out-of-sample) option pricing errors by 15% or more.
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The works this paper leans on most, across its whole bibliography — not restricted to papers in our corpus. Ranked by composite intensity, which combines how often a work is mentioned, how many sections mention it, and how much of that falls in the main text rather than the appendix.
| Reference | Intensity | Mentions | Sections | Main text | |
|---|---|---|---|---|---|
| 1 | Christoffersen, P., Heston, S. L., and Jacobs, K (2013) Capturing option anomalies with a variance-dependent pricing kernel | 1.000 | 6 | 3 | 100% |
| 2 | Huang, Z., Wang, T., and Hansen, P. R (2017) Option pricing with the realized GARCH model: An analytical approximation approach self | 0.956 | 8 | 6 | 88% |
| 3 | Christoffersen, P., Feunou, B., Jacobs, K., and Meddahi, N (2014) The economic value of realized volatility: Using high-frequency returns for option valuation | 0.928 | 4 | 3 | 100% |
| 4 | Majewski, A. A., Bormetti, G., and Corsi, F (2015) Smile from the past: A general option pricing framework with multiple volatility and leverage components | 0.811 | 4 | 2 | 100% |
| 5 | Barndorff-Nielsen, O. E., Hansen, P. R., Lunde, A., and Shephard, N (2008) Designing realised kernels to measure the ex-post variation of equity prices in the presence of noise self | 0.644 | 2 | 2 | 100% |
| 6 | Hansen, P. R., Huang, Z., and Shek, H (2012) Realized GARCH: A joint model of returns and realized measures of volatility self | 0.644 | 2 | 2 | 100% |
| 7 | Heston, S. L. and Nandi, S (2000) A closed-form GARCH option valuation model | 0.644 | 2 | 2 | 100% |
| 8 | Huang, Z., Tong, C., and Wang, T (2019) VIX term structure and VIX futures pricing with realized volatility self | 0.644 | 2 | 2 | 100% |
| 9 | Duan, J.-C., Gauthier, G., and Simonato, J (1999) An analytical approximation for the GARCH option pricing model | 0.511 | 3 | 2 | 33% |
| 10 | Gray, S. F (1996) Modeling the conditional distribution of interest rates as a regime-switching process | 0.511 | 2 | 1 | 100% |
Showing the top 10 of 45 scored citations.
arXiv econ.EM papers that cite this one, ranked by how heavily they lean on it.
| Citing paper | Intensity | Mentions | Sections | |
|---|---|---|---|---|
| 1 | Option Pricing with Time-Varying Volatility Risk Aversion | 0.405 | 1 | 1 |