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Department of Economics, Lund University Working Papers, Department of Economics, Lund University

No 2000:16:
Stochastic Volatility and Pricing Bias in the Swedish OMX-Index Call Option Market

Hans Byström ()

Abstract: This paper investigates the pricing bias in the Swedish OMX-Index Option market and how a stochastic volatility affects European call option prices. The market is purely European and without dividends for the period studied. A CIR square-root process for the volatility is estimated with non-linear least square minimization, and stochastic volatility option prices are calculated through Fourier-Inversion. These call option prices are compared to Black-Scholes prices as well as observed market prices, and a well-defined bias structure between Stochastic Volatility prices and Black-Scholes prices is observed. With a dynamic hedging scheme, I demonstrate larger (ex ante) profits, excluding transaction costs, for traders using the stochastic volatility model rather than the Black-Scholes model

Keywords: derivatives pricing; stochastic volatility; Fourier inversion; (follow links to similar papers)

JEL-Codes: C52; G13; (follow links to similar papers)

19 pages, November 6, 2000

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