Option Pricing with Time-Varying Volatility Risk Aversion
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arXiv
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| Hauptverfasser: | , |
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| Format: | Preprint |
| Veröffentlicht: |
2022
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| _version_ | 1866929747859079168 |
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| author | Hansen, Peter Reinhard Tong, Chen |
| author_facet | Hansen, Peter Reinhard Tong, Chen |
| contents | We introduce a pricing kernel with time-varying volatility risk aversion to explain observed time variations in the shape of the pricing kernel. When combined with the Heston-Nandi GARCH model, this framework yields a tractable option pricing model in which the variance risk ratio (VRR) emerges as a key variable. We show that the VRR is closely linked to economic fundamentals, as well as sentiment and uncertainty measures. A novel approximation method provides analytical option pricing formulas, and we demonstrate substantial reductions in pricing errors through an empirical application to the S&P 500 index, the CBOE VIX, and option prices. |
| format | Preprint |
| id |
arxiv_https___arxiv_org_abs_2204_06943 |
| institution | arXiv |
| publishDate | 2022 |
| record_format | arxiv |
| spellingShingle | Option Pricing with Time-Varying Volatility Risk Aversion Hansen, Peter Reinhard Tong, Chen Pricing of Securities Econometrics We introduce a pricing kernel with time-varying volatility risk aversion to explain observed time variations in the shape of the pricing kernel. When combined with the Heston-Nandi GARCH model, this framework yields a tractable option pricing model in which the variance risk ratio (VRR) emerges as a key variable. We show that the VRR is closely linked to economic fundamentals, as well as sentiment and uncertainty measures. A novel approximation method provides analytical option pricing formulas, and we demonstrate substantial reductions in pricing errors through an empirical application to the S&P 500 index, the CBOE VIX, and option prices. |
| title | Option Pricing with Time-Varying Volatility Risk Aversion |
| topic | Pricing of Securities Econometrics |
| url | https://arxiv.org/abs/2204.06943 |