Option Pricing Model Accuracy in Bullish & Bearish Markets: An empirical study on OMXS30 index call options
Independent thesis Advanced level (degree of Master (One Year)), 20 credits / 30 HE creditsStudent thesis
This thesis compares the accuracy of Heston’s stochastic volatility model and the Black-Scholes model in pricing Swedish OMXS30 call options. The purpose is to investigate when a model which assumes stochastic volatility prices with more accuracy than a model with constant volatility depending on the phase of the market and the scenarios that can occur there within. Our initial hypothesis was that the Heston model would outperform Black-Scholes on average but not for all market phases and scenarios. The findings suggest that Heston is, indeed, outperforming Black-Scholes on average. However, our results indicate that the mispricing errors can in fact be reduced by alternating between the models. One should alternate depending on whether the options are subject to a certain volatility, moneyness, risk-free rate, and days to maturity with respect to the market trend being bullish or bearish. The Heston model is preferred when volatility is high, and when options are deep out-of-the-money, regardless of market phase. Black-Scholes is preferred when volatility is low and when options are deep-in-the-money no matter which market phase. For at-the-money options, Heston is more accurate in the bearish timeframe while Black-Scholes is more accurate in the bullish timeframe. Generally, the Heston model should be used for out-of-the-money and Black-Scholes for in-the-money options no matter which market phase. However, for options with very long maturities, Black-Scholes is favored for out-of-the-money options in a bullish market but not in a bearish market.
Place, publisher, year, edition, pages
2016. , 53 p.
JIBS Research Reports, ISSN 1403-0462
Option pricing, Model Accuracy, Model Alternation, Stochastic Volatility, Market phases, Black-Scholes, Heston’s Stochastic Volatility Model
Economics Business Administration
IdentifiersURN: urn:nbn:se:hj:diva-30194ISRN: JU-IHH-NAA-2-20160048, JU-IHH-FÖA-2-20160212OAI: oai:DiVA.org:hj-30194DiVA: diva2:932960
2016-06-02, Jönköping, 15:10 (English)