Exploring Option Pricing and Hedging via Volatility Asymmetry

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.

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Notes

  1. 1.

    Leverage implies volatility asymmetry, but not all types of volatility asymmetry imply leverage. Hereafter, we refer to the broader concept of volatility asymmetry.

  2. 2.

    Note that the p values of the tests of kurtosis and skewness have been obtained using the procedure by Premaratne and Bera (2017), which allows us to test kurtosis in the presence of asymmetry and skewness in the presence of excess of kurtosis.

  3. 3.

    Hereafter, figures do not include “OP” in the model names due to lack of space.

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Acknowledgements

The second author acknowledges financial support from Spanish Ministry of Economy and Competitiveness, research projects ECO2015-70331-C2-2-R and PGC2018-096977-B-I00, and FCT Grant UID/GES/00315/2019.

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Correspondence to Isabel Casas.

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Appendix

Appendix

See Table 5.

Table 5 Description of sample periods

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Casas, I., Veiga, H. Exploring Option Pricing and Hedging via Volatility Asymmetry. Comput Econ (2020). https://doi.org/10.1007/s10614-020-10005-5

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Keywords

  • Delta hedging
  • Option
  • Stochastic volatility
  • Volatility asymmetry

JEL Classification

  • C22
  • C51
  • C58