Essays on volatility forecasting and option pricing efficiency

Abstract

Two topics with respect to volatility forecasting and one topic with respect to option pricing efficiency are investigated. All three topics have two things in common. One is that those are originally started from the shortcoming of Black and Scholes model. The other is that the usefulness of the stochastic volatility model is tested. The first study tries to find out a better way, which can derive the implied volatility from option prices, to overcome the forecasting bias from Black and Scholes model. Heston (1993)’s model which improves on the problems of Black and Scholes (1973) model the most for pricing and hedging options is one candidate, Model Free implied volatility which, is derived by Britten-Jones and Neuberger(2000), eliminates a model-oriented bias is another, and VIX which is the expected risk neutral value of realized volatility under the discrete version is the other. From the empirical analysis on KOSPI200 option market, it is found that Heston (1993)’s implied volatility eliminates the bias mostly which Black and Scholes (1973) implied volatility has. The second study conducts the intraday volatility forecast analysis and compares the performance of the implied volatility from the stochastic model with that from BS implied volatility. Contrary to the results from previous studies which investigate on a month ahead future volatility forecasting, this study which examines one hour ahead future volatility forecasting shows that the performance of the implied volatility from the stochastic volatility model is not better than that of BS implied volatility. The final study examines whether the “absolute smile” approach of ad hoc Black and Scholes model still dominates not only the “relative smile” approach but also Black and Scholes model and the stochastic volatility model when the time-to-maturity is taken into account in the ad hoc Black and Scholes model. In consistent with the results from previous studies, this study also supports the ...