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Review of Derivatives Research

, Volume 1, Issue 2, pp 139–157 | Cite as

Index-option pricing with stochastic volatility and the value of accurate variance forecasts

  • Robert F. Engle
  • Alex KaneEmail author
  • Jaesun Noh
Article

Abstract

In pricing primary-market options and in making secondary markets, financial intermediaries depend on the quality of forecasts of the variance of the underlying assets. Hence, pricing of options provides the appropriate test of forecasts of asset volatility. NYSE index returns over the period of 1968–1991 suggest that pricing index options of up to 90-days maturity would be more accurate when: (1) using ARCH specifications in place of a moving average of squared returns; (2) using Hull and White's (1987) adjustment for stochastic variance in the Black and Scholes formula; (3) accounting explicitly for weekends and the slowdown of variance whenever the market is closed. (JEL C22, C53, C10, G11, G12)

Keywords

GARCH forecasts index options variance volatility 

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Copyright information

© Kluwer Academic Publishers 1997

Authors and Affiliations

  1. 1.Department of EconomicsUniversity of CaliforniaSan Diego
  2. 2.Graduate School of International Relations and Pacific StudiesUniversity of CaliforniaSan Diego
  3. 3.Quantitative Micro SoftwareUSA

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